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Regular version of the site

Book chapter

How can Information on CDS Contracts be Used to Estimate Liquidity Premium in the Bond Market

P. 248-254.
Tarasova P. V.

Liquidity is an important characteristic for any bond, but now in the literature there are no models for estimating the liquidity premium. Moreover, there is not even an exact definition of this notion. There are many facts proving the existence of the liquidity premium in the bond market. One of such fact, for example, is the difference between values of the bond spread and the credit default swap (CDS) premium. Following the Longstaff (2005) study, often, in practice, CDS data are used for the estimation of the pure credit risk of the underlying bond and henc for the separation of the bond risk premium from the liquidity premium and credit risk premium. However, the fact that CDS premium can be used for the pure credit risk measurement is a disputable proposition. The purpose of this paper is to make recommendations on the applicability of such approach for assessing liquidity premium. In this paper the risks associated with CDS transactions will be considered.Also, different approaches for assessing the liquidity bond premium and liquidity CDS premium will be reviewed as well as the correlation of these quantitites. We will see that the CDS premium does not measure the pure credit component of the bond spread. 

In book

How can Information on CDS Contracts be Used to Estimate Liquidity Premium in the Bond Market
Edited by: D. Sornette, S. Ivliev, H. Woodard. Berlin: Springer, 2012.