The impact of liquidity on senior credit index spreads during the subprime crisis

Marra, M. ORCID: https://orcid.org/0000-0003-0810-7323 (2015) The impact of liquidity on senior credit index spreads during the subprime crisis. International Review of Financial Analysis, 37. pp. 148-167. ISSN 1057-5219 doi: 10.1016/j.irfa.2014.11.016

Abstract/Summary

This paper examines the effects of liquidity during the 2007–09 crisis, focussing on the Senior Tranche of the CDX.NA.IG Index and on Moody's AAA Corporate Bond Index. It aims to understand whether the sharp increase in the credit spreads of these AAA-rated credit indices can be explained by worse credit fundamentals alone or whether it also reflects a lack of depth in the relevant markets, the scarcity of risk-capital, and the liquidity preference exhibited by investors. Using cointegration analysis and error correction models, the paper shows that during the crisis lower market and funding liquidity are important drivers of the increase in the credit spread of the AAA-rated structured product, whilst they are less significant in explaining credit spread changes for a portfolio of unstructured credit instruments. Looking at the experience of the subprime crisis, the study shows that when the conditions under which securitisation can work properly (liquidity, transparency and tradability) suddenly disappear, investors are left highly exposed to systemic risk.

Item Type	Article
URI	https://reading-clone.eprints-hosting.org/id/eprint/39177
Identification Number/DOI	10.1016/j.irfa.2014.11.016
Refereed	Yes
Divisions	Henley Business School > Finance and Accounting
Uncontrolled Keywords	Senior Tranche CDX Index; Subprime crisis; Credit risk; Liquidity risk; Systemic risk
Publisher	Elsevier
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