CDS liq vs Physical Bonds

[DanMcg]

Hi Colin,

I seem to be getting conflicting views on the relative liquidity of CDS contracts versus physical. My understanding was the the CDS market is far larger/liquid than the physical bond market, but I did a past paper question [SA5 Apr15 Q1 (viii) & (ix)] which seems to allude to the opposite.

The only explanations I could come to was
(a) CDS contracts are more liquid than physical when looking at longer duration bonds but not shorter duration (the Apr15 question was referring to bonds with duration of <3 years)
(b)L iquidity/market conditions of CDS contracts (and bonds) were different prior to the financial crisis of 2008-09 where CDS were more popular - but now the CDS market is far smaller

Any thoughts?

 

[Colin McKee]

I dont think that SA6 Apr 2015 Q1 is actually the question you may have been looking at. But in terms of the answer to the question, I am not 100% sure having never had dealing experience in that market. There is some information in the solution to ST5 Sept 2014 Q5 which indicates that marketability "may" by greater for CDSs than corporates. Certainly there are more bonds that people can arrange a CDS on, compared to corporate bonds that are realistically investible. I suspect if this was examined the answer would be that there are some corporates that are large and extremely well traded, compared to the equivalent corporate. But likewise there will be certain corporates that are relatively illiquid, and a CDS based on that bond would be more marketable. PS SA6 Sept 2010 Q1 had some information about CDSs but was not very detailed.

 

[DanMcg]

you are quite right - question was from SA5 not SA6. But the above makes sense - thank you for that.