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Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity by Frédéric Patras, Damiano Brigo, Tomasz R. Bielecki

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Chapter 19

Liquidity Modeling for Credit Default Swaps: An Overview

Damiano Brigo

Gilbart Professor of Financial Mathematics, King's College, London

Mirela Predescu

BNP Paribas, London

Agostino Capponi

School of Industrial Engineering, Purdue University

We review different theoretical and empirical approaches for measuring the impact of liquidity on CDS prices. We start with reduced-form models incorporating liquidity as an additional discount rate. We review Chen, Fabozzi, and Sverdlove (2008); Chen, Cheng, and Wu (2005); and Buhler and Trapp (2006, 2008), adopting different assumptions on how liquidity rates enter the CDS premium rate formula, about the dynamics of liquidity rate processes and about the credit-liquidity correlation. Buhler ...

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