Credit default swaps and corporate bond trading

Using regulatory data on CDS holdings and corporate bond transactions, I provide evidence for a liquidity spillover effect from CDS to bond markets. Bond trading volumes are 70% larger for investors with CDS positions written on the debt issuer. Moreover, higher CDS trading activity substantially improves the liquidity of the underlying bonds, particularly around rating downgrades. Additional analyses reveal that the spillover effect is partly driven by naked CDS positions, highlighting one of the adverse consequences of naked CDS bans for bond markets. The results suggest that the presence of an accessible CDS market enhances the liquidity of the underlying bond market.