A Theory of Liquidity Spillovers Between Bond and CDS Markets
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چکیده
During the recent debt crisis in Europe, policy makers responded to the controversy surrounding CDS by implementing a series of policies that banned CDS trading. Sambalaibat (2014) documents that a temporary CDS ban increased bond market liquidity but a permanent ban instead decreased bond market liquidity. To explain these patterns, I build a search-theoretic model of OTC bond and CDS markets that features an endogenous liquidity interaction between the two markets and endogenous funding liquidity. I show that these opposing patterns are due to the fact that bond and CDS markets are substitute markets in the short run but are complementary markets in the long run. My results challenge existing theories of liquidity interaction among multiple markets and the common perception that the CDS market is a more liquid market than the bond market.
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