The liquidity premium in CDS transaction prices: Do frictions matter?

- We use a proprietary set of individual CDS transactions.
- We show that CDS prices contain sizeable, counterparty-specific liquidity premiums.
- We attribute the liquidity premium to specific market frictions.
- Asymmetric information does not play a role.
- Buy-side investors pay a significantly higher price for liquidity than dealers.

Based on individual CDS transactions cleared by the Depository Trust & Clearing Corporation, we show that illiquidity strongly affects credit default swap premiums. We identify the following effects: first, transaction direction affects prices, as buy (sell) orders lead to premium increases (decreases). Second, larger transactions have a higher price impact. This finding stands in stark contrast to corporate bond markets. Third, traders charge higher premiums as a price for liquidity provision, not as compensation for asymmetric information. Fourth, buy-side investors pay significantly higher prices than dealers for demanding liquidity. Finally, inventory risk seems to matter little in explaining liquidity premiums.