Journal of Financial Services Research

, Volume 32, Issue 3, pp 141–159 | Cite as

Trading Credit Default Swaps via Interdealer Brokers

  • Yalin GündüzEmail author
  • Torsten Lüdecke
  • Marliese Uhrig-Homburg


Credit default swaps (CDSs) are among the most successful financial innovations of recent years, which is reflected in the rapidly expanding market. CDS trading occurs in the over-the-counter market, which relies heavily on broker intermediation to arrange trades. We provide empirical evidence that liquidity in the voice brokered market varies with the particulars of the CDS contracts and that the differences in market structure is reflected in the costs of liquidity. Moreover, the brokered and direct interdealer trading markets seem to be well integrated; thus the higher liquidity costs in the brokered market may reflect the value of intermediation. Hybrid market structures, which combine voice brokerage with an electronic platform, are discussed as a viable alternative to fully automated trading systems.


Credit default swaps market microstructure over-the-counter trading interdealer brokerage liquidity 

JEL Classifications

G15 G24 


  1. Acharya VV, Johnson TC (2007) Insider trading in credit derivatives. J Financ Econ 84:110–141CrossRefGoogle Scholar
  2. Bagehot W (1971) The only game in town. Financ Anal J 27:12–14, 22CrossRefGoogle Scholar
  3. Bank for International Settlements (2005) OTC derivatives market activity in the second half of 2004. Bank for International Settlements, Monetary and Economic DepartmentGoogle Scholar
  4. Barclay MJ, Hendershott T, Kotz K (2006) Automation versus intermediation: evidence from treasuries going off the run. J Finance 61:2395–2414CrossRefGoogle Scholar
  5. Bessembinder H, Venkataraman K (2004) Does an electronic stock exchange need an upstairs market? J Financ Econ 73:3–36CrossRefGoogle Scholar
  6. Bessembinder H, Maxwell W, Venkataraman K (2006) Market transparency, liquidity externalities and institutional trading costs in corporate bonds. J Financ Econ 82:251–288CrossRefGoogle Scholar
  7. Biais B (1993) Price formation and equilibrium liquidity in fragmented and centralized markets. J Finance 48:157–185CrossRefGoogle Scholar
  8. Blanco R, Brennan S, Marsh IW (2005) An empirical analysis of the dynamic relationship between investment-grade bonds and credit default swaps. J Finance 60:2255–2281CrossRefGoogle Scholar
  9. Bloomfield R, O’Hara M (2000) Can transparent markets survive? J Financ Econ 55:425–459CrossRefGoogle Scholar
  10. Boni L, Leach C (2004) Expandable limit order markets. J Financ Mark 7:145–185CrossRefGoogle Scholar
  11. Brenner M, Eldor R, Hauser S (2001) The price of options illiquidity. J Finance 56:789–805CrossRefGoogle Scholar
  12. British Bankers’ Association (2004) BBA Credit Derivatives Report 2003/2004, British Bankers’ Association, UKGoogle Scholar
  13. Copeland TE, Galai D (1983) Information effects on the bid-ask spread. J Finance 38:1457–1469CrossRefGoogle Scholar
  14. Demsetz H (1968) The cost of transacting. Q J Econ 82:35–53CrossRefGoogle Scholar
  15. Deuskar P, Gupta A, Subrahmanyam MG (2006) Liquidity effects in interest rate options markets: premium or discount? Unpublished working paper, New York University, NYGoogle Scholar
  16. D’Souza C, Gaa C, Yang J (2003) An empirical analysis of liquidity and order flow in the brokered interdealer market for government of Canada bonds. Unpublished working paper, Bank of Canada, 2003-28, CanadaGoogle Scholar
  17. Duffie D (1999) Credit swap valuation. Financ Anal J 55:73–87CrossRefGoogle Scholar
  18. Duffie D, Garleanu N, Pedersen LH (2005) Over-the-counter markets. Econometrica 73:1815–1847CrossRefGoogle Scholar
  19. Easley D, Kiefer NM, O’Hara M et al (1996) Liquidity, information, and infrequently traded stocks. J Finance 51:1405–1436CrossRefGoogle Scholar
  20. Flood MD, Huisman R, Koedijk KG et al (1999) Search costs: the neglected spread component. Unpublished working paper, University of California, Berkeley, CAGoogle Scholar
  21. Garbade KD (1978) The effect of interdealer brokerage on the transactional characteristics of dealer markets. J Bus 51:477–498CrossRefGoogle Scholar
  22. Glosten LR, Milgrom PR (1985) Bid, ask and transaction prices in a specialist market with heterogeneously informed traders. J Financ Econ 14:71–100CrossRefGoogle Scholar
  23. Grossman SJ (1992) The information role of upstairs and downstairs markets. J Bus 65:509–528CrossRefGoogle Scholar
  24. Ho TSY, Stoll HR (1983) The dynamics of dealer markets under competition. J Finance 38:1053–1074CrossRefGoogle Scholar
  25. Houweling P, Vorst T (2005) Pricing default swaps: empirical evidence. J Int Money Financ 24:1200–1225CrossRefGoogle Scholar
  26. Houweling P, Mentink A, Vorst T (2005) Comparing possible proxies of corporate bond liquidity. J Bank Financ 29:1331–1358CrossRefGoogle Scholar
  27. Huang RD, Cai J, Wang X (2002) Information-based trading in the treasury note interdealer broker market. J Financ Intermed 11:269–296CrossRefGoogle Scholar
  28. Hull J, White A (Fall 2000) Valuing credit default swaps I: no counterparty default risk. J Deriv 8:29–40Google Scholar
  29. Hull J, White A (Spring 2001) Valuing credit default swaps II: modeling default correlations. J Deriv 8:12–21CrossRefGoogle Scholar
  30. International Swaps and Derivatives Association (2004) ISDA 2004 Operations Benchmarking Survey, ISDA Inc.Google Scholar
  31. International Swaps and Derivatives Association (2006) ISDA 2006 Operations Benchmarking Survey, ISDA Inc.Google Scholar
  32. Janosi T, Jarrow R, Yildirim Y (2002) Estimating expected losses and liquidity discounts implicit in debt prices. J Risk 5:1–38CrossRefGoogle Scholar
  33. Lehmann BN (2002) Some desiderata for the measurement of price discovery across markets. J Financ Mark 5:259–276CrossRefGoogle Scholar
  34. Longstaff FA, Mithal S, Neis E (2005) Corporate yield spreads: default risk or liquidity? New evidence from the credit default swap market. J Finance 60:2213–2253CrossRefGoogle Scholar
  35. Madhavan A (1996) Security prices and market transparency. J Financ Intermed 5:255–283CrossRefGoogle Scholar
  36. Madhavan A, Porter D, Weaver D (2005) Should securities markets be transparent? J Financ Mark 8:265–287CrossRefGoogle Scholar
  37. Odders-White ER, Ready MJ (2006) Credit ratings and stock liquidity. Rev Financ Stud 19:119–157CrossRefGoogle Scholar
  38. O’Hara M (1995) Market microstructure theory, Cambridge, MA: BlackwellGoogle Scholar
  39. Pagano M, Roell A (1996) Transparency and liquidity: a comparison of auction and dealer markets with informed trading. J Finance 51:579–611CrossRefGoogle Scholar
  40. Reiss PC, Werner IM (1998) Does risk sharing motivate interdealer trading? J Finance 53:1657–1703CrossRefGoogle Scholar
  41. Reiss PC, Werner IM (2005) Anonymity, adverse selection, and the sorting of interdealer trades. Rev Financ Stud 18:599–636CrossRefGoogle Scholar
  42. Rime D (2003) New electronic trading systems in foreign exchange markets. In: Jones DC (ed.) New economy handbook. Amsterdam: Academic Press/Elsevier, pp. 471–507Google Scholar
  43. Schwartz RA, Francioni R (2004) Equity markets in action: the fundamentals of liquidity, market structure and trading. Hoboken, NJ: Wiley & SonsGoogle Scholar
  44. Stoll H (2000) Friction. J Finance 55:1479–1514CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2007

Authors and Affiliations

  • Yalin Gündüz
    • 1
    Email author
  • Torsten Lüdecke
    • 1
  • Marliese Uhrig-Homburg
    • 1
  1. 1.Institute of Finance, Banking, and InsuranceUniversity of Karlsruhe (TH)KarlsruheGermany

Personalised recommendations