Market Liquidity in a Natural Experiment: Evidence from CDS Standard Coupons

The credit default swap (CDS) Big Bang introduced 2 standard coupons for CDS trading. We exploit the setting of the 2 standard coupons as a natural experiment to quantify the components of the bid-ask spreads in over-the-counter markets. We find that a significant portion of the difference in the bid-ask spread between the 2 coupons is explained by the difference in funding costs. Furthermore, search intensity also explains the variation in the difference in bid-ask spread. The liquidity typically concentrates on one of the standard coupons and can suddenly switch to the other coupon. Using the sudden switch of the primary coupon, we provide further evidence to support the predictions of search-based liquidity models.