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Contents lists available at ScienceDirect

Journal of Financial Economics

journal homepage: www.elsevier.com/locate/jfec

Funding liquidity shocks in a quasi-experiment: Evidence

from the CDS Big Bang ✩
Xinjie Wang a, Yangru Wu b, Hongjun Yan c, Zhaodong (Ken) Zhong b,∗
a
Department of Finance, Southern University of Science and Technology, 1088 Xueyuan Blvd., Shenzhen, Guangdong 518055, China
b
Department of Finance and Economics, Rutgers Business School, Rutgers University, 100 Rockafeller Road, Piscataway, NJ 08854, United
States
c
Department of Finance, DePaul University, 1 E. Jackson Blvd., Suite 5500, Chicago, IL 60604, United States

a r t i c l e i n f o a b s t r a c t

Article history: We use the advent of new credit default swap (CDS) trading conventions in April 2009—
Received 23 October 2018 the CDS Big Bang—to study how a shock to funding liquidity impacts market liquidity. After
Revised 26 November 2019
the Big Bang, traders are required to pay upfront fees to execute CDS transactions, with the
Accepted 23 December 2019
size of the fees depending on the level of CDS spreads. While CDS bid-ask spreads decline
Available online xxx
in aggregate after the Big Bang, they do so less for contracts that require larger fees. Fur-
JEL Classification: thermore, the funding effect is stronger for smaller and riskier firms and for noncentrally
G11 cleared contracts. The effect also becomes stronger after Deutsche Bank’s exit.
G12 © 2020 Elsevier B.V. All rights reserved.
G13
G14
G18
G28

Keywords:
Funding liquidity
CDS Big Bang
CDS Small Bang
Standardization
Central clearing

1. Introduction
✩
We thank Jennie Bai, Bo Becker, Bruno Biais, Patrick Bolton, James
Dow, Darrell Duffie, William Fuchs, Benjamin Golez, Florian Heider, Anas-
Intuitively, a funding shock for market participants im-
tasia Kartasheva, David Lando, Ji-Chai Lin, Sebastien Michenaud, Ailsa
Roell, David Skeie, Dragon Tang, Baolian Wang, Sarah Wang, John Wei, pairs their ability to trade, which leads to a fall in market
Hong Yan, Fan Yu, and seminar or conference participants at the Ameri- liquidity and pushes prices away from fundamentals. As
can Finance Association Annual Meeting, Australasian Finance and Bank- market liquidity dries up, margin requirements could also
ing Conference, CEPR European Summer Symposium in Financial Markets,
rise and exacerbate existing losses, resulting in a liquidity
China International Conference in Finance, European Winter Finance Con-
ference, Financial Management Association Annual Meeting, Hong Kong
spiral. The goal of this paper is to test whether a causal
Polytechnic University, Shanghai Advanced Institute of Finance, and Triple link between funding liquidity and market liquidity exists
Crown Conference for their helpful comments. Special thanks go to an empirically.
anonymous referee and the editor, Bill Schwert, for helpful comments and Identifying a causal relation between funding liquid-
suggestions that significantly improved the paper. Xinjie Wang acknowl-
ity and market liquidity is challenging because exogenous
edges financial support from the Southern University of Science and Tech-
nology under the Startup Grant (Y01246210, Y01246110). shocks to funding liquidity are rather rare. We use the ad-
∗
Corresponding author. vent of the standardized fixed coupons for trading credit
E-mail address: zdzhong@business.rutgers.edu (Z. Zhong). default swap (CDS) in April 2009, the so-called CDS Big

https://doi.org/10.1016/j.jfineco.2020.08.004
0304-405X/© 2020 Elsevier B.V. All rights reserved.

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
JID: FINEC
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2 X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx

Fig. 1. Average bid-ask spread. This figure plots monthly average bid-ask spreads around the CDS Big Bang from October 2008 to October 2009. The bid-ask
spread is averaged across firms and by month in the North American CMA sample. The vertical dashed line indicates the effective date, April 8, 2009, of
the Big Bang.

Bang, as a shock to funding requirements of trading CDS
contracts and then trace out its ensuing impact on market
liquidity. Our main finding is that, consistent with theory,
funding costs are negatively related to market liquidity.
To illustrate how the Big Bang provides a shock to fund-
ing liquidity, we compare the funding requirements before
and after the Big Bang. Before the Big Bang, buyers of CDS
protection paid sellers a fair-value spread such that the
net present value (NPV) of the contract was zero at the
start of the contract. Therefore, aside from any initial mar-
gins, trading CDSs required no upfront capital from either
buyers or sellers. However, after the Big Bang, buyers of
CDS protection pay sellers a chosen fixed coupon, e.g., 100
or 500 basis points (bps), instead of the fair-value spread.
To compensate for the difference between the fair-value
spread and the chosen standard coupon rate, an additional
upfront payment is exchanged between buyers and sellers
to make the NPV of the contract equal to zero at incep-
tion. For example, if the fair-value spread is 200 bps and
the chosen fixed coupon is 100 bps, then the buyer would
pay the seller an upfront amount that is the present value
of the difference between the 200 bps fair-value spread
and the 100 bps fixed coupon. It is estimated that the
aggregate upfront fee is about $4 billion per month in
the single-name CDS market (see institutional details in
Section 2.1).
The CDS Big Bang helps us empirically identify the
causal link between funding liquidity and market liquidity.
As the above example makes clear, the larger the deviation
of the fair-value spread from the fixed coupon, the more
capital that is required upfront (i.e., the size of the upfront
fees depends on the level of CDS spreads). Therefore, while
overall market liquidity improves after the Big Bang, we
use the fact that some firms require larger upfronts than
others to test whether their market liquidity improves at a
slower pace. More specifically, we expect that the liquidity
improvement is smaller for firms with larger upfront pay-
ments after the Big Bang.
We begin our investigation by showing that the average
bid-ask spread in the CDS market decreases after the Big
Bang. We calculate the average bid-ask spread across firms
and present the results in Fig. 1. As expected, the results
show that the average bid-ask spread decreases after the
Big Bang, suggesting that coupon standardization generally
increases aggregate market liquidity.
In the main empirical analysis, we compare the impact
of different upfront payments, which are interpreted as an
increase in funding costs, on market liquidity. We find that
after the Big Bang, CDS contracts that require larger up-
front payments are also those that have less liquidity in
the form of wider bid-ask spreads. The relation is also eco-
nomically and statistically significant. For example, for a
contract that is 100 bps away from the fixed coupon (e.g.,
a 200 bps fair-value spread relative to the 100 bps fixed
coupon), the bid-ask spread increases by 0.76 bps after the
Big Bang. To put the magnitude in perspective, the bid-
ask spread for this contract increases by about 8% (14%)
relative to the sample mean (median) bid-ask spread of
9.61 bps (5.30 bps).
We also use CDS contracts with different maturities
to identify the impact of upfront funding costs on mar-
ket liquidity. We find that the empirical results and point
estimates utilizing variation across maturities but within
firms are similar to our main analysis. Overall, our find-
ings are consistent with the prediction that larger upfront
payments result in less market liquidity improvement.
To reinforce the notion that shifts in funding costs for
traders have a causal impact on the market liquidity, we
provide a number of robustness checks. First, we examine
whether there are heterogeneous effects based on size and
rating. One would expect that the funding effect is stronger
for riskier and less liquid securities. Indeed, we find that
the funding effect is stronger for CDS contracts on smaller
and riskier reference entities.
Next, it is reasonable to think that, through more ef-
ficient netting, central clearing can reduce the impact of

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
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upfront payments. In December 2009, eight months af-
ter the CDS Big Bang, ICE Clear Credit (ICECC) started to
clear single-name CDS trades. Central clearing can facili-
tate netting since the central counterparty (CCP) serves as
the sole counterparty for all parties (see Section 2.1 for in-
stitutional details). Thus, central clearing should mitigate
the burden of upfront payments. Consistent with this pre-
diction, we find that central clearing reduces the effect of
upfront funding costs on the bid-ask spread.
Another event in the CDS market that occurred after
the CDS Big Bang was the exit of Deutsche Bank from
the single-name CDS market in late 2014. This event cre-
ates another shock to the aggregate market-making capac-
ity in the CDS market. Since the funding effect is stronger
when traders’ capital constraint is closer to being binding
(Brunnermeier and Pedersen, 2009), the effect of upfront
funding costs on the bid-ask spread should increase fol-
lowing the Deutsche Bank’s exit. Consistent with this pre-
diction, we find that the effect of upfront funding costs on
the bid-ask spread indeed increases after Deutsche Bank’s
exit.
Finally, we use liquidity in the corporate bond market
and the equity market to conduct placebo tests. Because
the upfront payments introduced by the CDS Big Bang only
affect CDS contracts, it should not impact bond or stock
market trading. As expected, we show that the CDS up-
front funding cost has no impact on bond or stock bid-ask
spreads. In addition, we compare the gap between CDS and
bond liquidity before and after the Big Bang and find re-
sults consistent with our main hypothesis. We also explore
the asymmetric effects of upfront funding costs and find
that the funding cost effect is stronger when dealers pay
upfront.
Our paper contributes to the literature on the effects
of traders’ capital constraints in financial markets. Im-
portant theoretical contributions include Grossman and
Miller (1988), Shleifer and Vishny (1997), Basak and
Croitoru (20 0 0), Xiong (20 01), Kyle and Xiong (20 01),
Gromb and Vayanos (2002), Brunnermeier and Peder-
sen (2009), Garleanu and Pedersen (2011), He and Krish-
namurthy (2013), and Brunnermeier and Sannikov (2014),
among others. Several studies provide important empir-
ical evidence for the financial intermediary-based asset
pricing models (e.g., Adrian et al., 2014; He et al., 2017;
Siriwardane, 2019).1 Complementary to these studies, our
paper uses the CDS Big Bang to provide a novel empirical
test of the mechanism relating funding liquidity to market
liquidity.
Market liquidity and funding liquidity have been ana-
lyzed in various contexts (e.g., Coughenour and Saad, 2004;
Chordia et al., 2005; Comerton-Forde et al., 2010;
Hameed et al., 2010; Karolyi et al., 2012). Several stud-
ies use major market events as exogenous shocks to the
funding condition of financial intermediaries to examine
their effects on market liquidity (e.g., Acharya et al., 2015;
Aragon and Strahan, 2012; Dick-Nielsen et al., 2012). In this
paper, we use the CDS Big Bang, which presents an ar-
1
Mitchell et al. (2007) and Mitchell and Pulvino (2012) show cases in
which arbitrage capital appears to be slow in exploiting opportunities.
Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
[m3Gdc;August 22, 2020;6:7]
3
guably pure shock to funding requirements in the market,
to show empirically that an increase in funding require-
ments leads to a decrease in market liquidity.
Our paper is also related to the studies of the standard-
ization of the over-the-counter (OTC) derivatives markets
(e.g., Chen et al., 2011; Oehmke and Zawadowski, 2015,
2017; Augustin et al., 2016). Despite the benefits of stan-
dardization, derivatives end-users could find it more diffi-
cult to find products that exactly match their needs (e.g.,
Stulz, 2010; Duffie, Li, and Lubke, 2010). Our analysis high-
lights the mechanism through which the standardization
of CDS contracts affects market liquidity. The CDS Big Bang
or Small Bang has been used to study the empty credit hy-
pothesis (Danis, 2017), liquidity spillover from CDS to eq-
uity markets (Haas and Reynolds, 2019), and the effect on
credit availability (Gunduz et al., 2017). However, none of
these papers examines the cross-sectional effect of upfront
payments induced by the CDS Big Bang, which is the focus
of our paper.
Last, our paper also adds to the large literature on
the liquidity in the CDS market (e.g., Longstaff et al.,
2005; Tang and Yan, 2007; Bongaerts et al., 2011;
Qiu and Yu, 2012; Shachar, 2012; Chen et al., 2013;
Loon and Zhong, 2014; Eisfeldt et al., 2018). See
Augustin et al. (2016) for a recent survey on this literature.
The remainder of the paper is organized as follows. In
Section 2, we describe institutional details and data. In
Section 3, we discuss our main results of using the CDS
Big Bang to establish the causal link between funding liq-
uidity and market liquidity. We also conduct an analysis
using the variation across maturities but within firms in
this section. In Section 4, we examine the robustness of
our central findings, such as heterogeneous effects based
on size and rating, the introduction of central clearing, the
exit of Deutsche Bank from the single-name CDS market,
and placebo tests using bond and stock. Finally, we con-
clude the paper in Section 4.3.
2. Institutional background and data
In this section, we describe the institutional background
of our setting, data sources, and upfront funding cost mea-
sures.
2.1. Institutional background
To standardize CDS contracts, the International Swaps
and Derivatives Association (ISDA) introduced a collection
of contract and trading convention changes in the CDS
market on April 8, 2009, known as the CDS Big Bang
(for more details, see Markit, 2009a). The changes in the
CDS Big Bang include fixed coupon rates and upfront pay-
ments, standard effective dates, determinations commit-
tees, and auction settlement changes. The purpose of these
changes is to standardize CDS contracts and improve mar-
ket liquidity (JPMorgan, 2009). The relevant change for
our study is trading with fixed coupons and upfront pay-
ments. Before the CDS Big Bang, a single-name CDS con-
tract was traded at a coupon rate (i.e., fair-value spread)
that set the contract value to zero on the inception day.
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After the trading convention change, however, North Amer-
ican CDS contracts trade with two fixed coupons of 100
and 500 bps. Since the CDS spread is typically not ex-
actly equal to the fixed coupons, upfront payments are re-
quired to trade CDS contracts. Soon after the implemen-
tation of the CDS Big Bang, the ISDA published similar
trading convention changes for European single-name CDS
contracts on June 20, 2009, known as the CDS Small Bang,
after which European CDS contracts trade with four fixed
coupons of 25, 10 0, 50 0, and 10 0 0 bps (for more details,
see Markit, 2009b).
The intention of the trading convention change is to
standardize CDS contracts to facilitate trade compression
and central clearing. However, this trading convention
change also induces an upfront payment whose size de-
pends on the CDS spread level. Suppose, for example, that
a contract has a CDS spread of 200 bps. That is, the
breakeven coupon rate is 200 bps—the contract is worth
zero on the inception day if the coupon rate is set to be
200 bps. After the CDS Big Bang, however, the coupon
rate can only be either 100 or 500 bps. Suppose that the
coupon rate is set to be 100 bps. Since this coupon rate is
100 bps less than the breakeven rate (200 bps), the pro-
tection buyer needs to compensate the seller by paying an
upfront fee that is equal to the present value of 100 bps
per year during the life of the CDS contract. Alternatively,
suppose that the coupon rate is set to be 500 bps. Since
this coupon rate is 300 bps more than the breakeven rate
(200 bps), the protection seller needs to pay an upfront
fee that is equal to the present value of 300 bps per year
during the life of the CDS contract. Naturally, in practice,
the coupon is typically chosen to minimize the upfront
fee. Hence, in the above example of a contract with a CDS
spread of 200 bps, the coupon rate is typically chosen to
be 100 bps. In summary, the CDS Big Bang induces up-
front fees. The size of the fee depends on the CDS spread
level: it is larger if the CDS spread is further away from the
coupon rate.
How large is this upfront fee in aggregate? In our main
sample, the average size of the upfront fee is about 4.07%
of the notional amount of CDS contracts. According to the
Trade Information Warehouse (TIW) reports from the De-
pository Trust and Clearing Corporation (DTCC), the gross
notional value of single-name CDS trades executed be-
tween April and December 2009 is about $10 trillion. In
addition, Duffie et al. (2015) estimate the ratio between
net and gross notional amounts of single-name CDS to be
around 7.6%. Hence, the aggregate net notional amount of
single-name CDS trades during this period is estimated to
be about $0.76 trillion. Excluding the upfront fees for all
offsetting positions, the aggregate monthly upfront fee for
these new trades is approximately $3.87 billion.2
Since there were margin requirements for CDS trading
even before the CDS Big Bang, the funding cost induced by
upfront payments is in addition to the funding cost for the
margins for CDS trades (see, e.g., Duffie et al., 2015). Be-
fore the CDS Big Bang, in a trade between a dealer and a
2
The estimate of 3.87 billion is equal to 0.76 trillion multiplied by
4.07% divided by eight, where eight is the number of months from April
to December 2009.
Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
[m3Gdc;August 22, 2020;6:7]
customer, an initial margin is generally required at the in-
ception for the customer but not for the dealer (although
proposed regulatory reforms will also require dealers to
post initial margins for inter-dealer trades). Moreover, vari-
ation margins are posted by both parties and are adjusted
over time according to their collateral agreement when the
mark-to-market value of the CDS contract changes. After
the CDS Big Bang, on the inception day of a trade, a trader
pays the upfront fee and the counterparty typically posts
the received fee as the variation margin. This upfront pay-
ment is an extra funding requirement in addition to the
initial margin.3
It is also important to point out that the funding costs
also depend on trade size or traders’ aggregate position.
If trade size or aggregate exposure for traders decreases,
then there might not really be an increase in the aggre-
gate funding cost after the CDS Big Bang. According to
“CDS market summary: market risk transaction activity,”
ISDA research notes in 2013, the aggregate level of CDS
gross notional outstanding has indeed decreased since the
global financial crisis. However, the ISDA research notes
also show that the decrease has mostly been caused by
portfolio compression (also called trade tear-ups), which
eliminates economically redundant trades and reduces no-
tional outstanding. The purpose of portfolio compression is
to decrease CDS gross notional amounts outstanding while
not changing the economic details of a party’s net position.
The ISDA research notes suggest that a better way to un-
derstand the CDS market dynamics is to look at trading ac-
tivities in the market, as opposed to transactions outstand-
ing at a point in time. According to the data shown in the
ISDA research notes, there are only slight decreases in the
gross notional of new market risk transaction activities and
the average trade size of single-name CDSs.4 Given that
the upfront fees went up from zero to about 4% for single-
name CDSs around the CDS Big Bang, it is reasonable to
expect a funding cost shock around the CDS Big Bang.
Moreover, after the CDS Big Bang, there is a nonmonotonic
relation around the fixed 100 or 500 bps coupons. Our
analysis is based on this nonmonotonic relation.
After the global financial crisis, the US Congress passed
the Dodd-Frank Wall Street Reform and Consumer Pro-
tection Act, which mandates central clearing for eligible
OTC derivatives including CDSs. ICECC began central clear-
ing services for single-name CDSs in December 2009. Over
time, more CDS contracts became eligible for central clear-
ing. By the end of our sample period, October 2016, CDS
contracts for 243 North American firms had been centrally
cleared at ICECC. For centrally cleared transactions, the
central counterparty clearing house stands between traders
and serves as the sole counterparty for all traders. Thus,
3
For more details on the funding requirement changes induced by the
CDS Big Bang, please see Elizalde and Doctor, 2009. The bond-CDS fund-
ing basis. Europe Credit Derivatives Research Report, J.P. Morgan Securities
Ltd.
4
DTCC measures market risk transaction activity as transactions that
change the risk position between two parties, which include new trades
between two parties, a termination of an existing transaction, or the as-
signment of an existing transaction to a third party.
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central clearing has implications for the treatment of up-
front payments.
Before central clearing, suppose that a dealer sells pro-
tection on a reference entity to investor A and, to offset
this exposure, buys protection on the same reference en-
tity from investor B. In this case, the dealer needs to pay
an upfront fee for one position and receives an upfront
fee of a similar size for the other. Suppose, then, that the
dealer receives an upfront fee from A and pays an upfront
fee to B. Without central clearing, although these two off-
setting payments are similar in size, the dealer cannot net
them.5 Specifically, for the trade between the dealer and
A, the mark-to-market value of the CDS contract for in-
vestor A is the size of the upfront fee. Hence, on the one
hand, the dealer needs to post the fee from A as collat-
eral for this trade.6 On the other hand, the dealer has to
finance the upfront fee for the trade with investor B. After
central clearing, for centrally cleared transactions, the CCP
serves as the sole counterparty for all parties. In the above-
mentioned example, the dealer has two offsetting positions
with two different investors (A and B). If both positions are
cleared at the same CCP, the dealer now effectively has two
offsetting positions with the same counterparty.7 Hence,
the dealer can net the two offsetting upfront fees.
2.2. Data and upfront funding cost measures
The goal of the paper is to study the causal link be-
tween funding costs and market liquidity. We assume the
capital upfront payments introduced by the CDS Big Bang
as an increase in funding costs. In the following sections,
we describe our data and the measures of funding costs
and market liquidity.
2.2.1. Data and summary statistics
We obtain daily bid and ask quotes for CDS contracts
on North American companies from two sources. Our main
analysis is based on the data from Credit Market Analy-
sis Ltd. (CMA) via Datastream, which we refer to as the
North American CMA sample. In the main analyses, we fo-
cus on the five-year CDS contracts since they are the most
liquid and most widely traded contracts. The sample con-
sists of 634 companies from January 1, 2004 to September
30, 2010.8 Hence, this sample covers about five years be-
fore and one-and-a-half years after the CDS Big Bang. Our
second CDS data source is the Liquidity Report from the
5
A practice known as rehypothecation could allow the receiver of col-
lateral (usually a dealer) to use the collateral for his or her own purposes,
with permission from the payer of the collateral. However, the Dodd-
Frank Act puts restrictions on the rehypothecation for derivatives.
6
If there is a collateral agreement between two trading parties, the
party that receives an upfront fee is not entitled to retain the payment
but must post the payment as collateral to the payer. Collateral is usually
held either by dealers’ internal custody services or by a third agent upon
the request of the counterparty. In either case, once the upfront fee is
transferred to a custody account, neither party can use the payment for
their own purposes. For more details, see The Standard Credit Support
Annex, ISDA, 2011.
7 10
As noted in Duffie and Zhu (2011), central clearing cannot fully ad-
dress the netting issue if there are multiple clearing houses.
8
From October 1, 2010, CMA data are not available without a separate
license.
Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
[m3Gdc;August 22, 2020;6:7]
5
CDS Pricing Data of Markit Group Ltd., which we will refer
to as the North American Markit sample. Its five-year CDS
contracts cover 765 North American companies (of which,
319 are also in our CMA sample) from April 1, 2010 to Oc-
tober 19, 2016. That is, the Markit sample only covers the
post-Big-Bang period. Nevertheless, it is a useful comple-
ment to our CMA data.
To analyze the CDS Small Bang, we also obtain similar
CDS data for European companies from CMA and Markit.
The European CMA sample covers 423 companies from
January 1, 2004 to September 30, 2010. The European
Markit sample covers 547 companies from April 1, 2010 to
October 19, 2016.
We apply the following filters to the CDS bid and ask
quotes for all samples. We remove observations where the
bid quote is greater than or equal to the ask quote or
where the quote is indicated as “derived” rather than “ob-
served.” To improve the identification of the funding effect,
we also remove observations if the midpoint of the bid and
ask quotes is greater than 750 bps for the North Amer-
ican samples and 1,0 0 0 bps for the European samples.9
After applying these filters, the North American CMA and
Markit samples consist of 633,977 (620 firms) and 659,618
(728 firms) daily observations, respectively. The European
CMA and Markit samples consist of 421,667 (401 firms)
and 480,117 (540 firms) daily observations, respectively.
Table 1 reports summary statistics. Each variable is
pooled over time and across firms. Panel A shows that
the mean and median of the bid-ask spread in the North
American CMA sample are 9.61 and 5.30 bps, respectively.
In the North American Markit sample in Panel B, the mean
and median are slightly higher, at 12.39 and 10.00 bps,
respectively.10 As shown in Panels C and D, the bid-ask
spread in the European samples has very similar mean and
median values as the North American samples.
The credit ratings of the reference entities in our sam-
ples are mostly between A and B, according to S&P long-
term issuer credit ratings. The mean and median CDS
spreads are 137 and 71 bps in our North American CMA
sample and 155 and 102 bps in our North American Markit
sample. Similar to the North American samples, the mean
and median CDS spreads are 114 and 60 bps in our Euro-
pean CMA sample and 157 and 105 bps in our European
Markit sample.
As control variables, we obtain North American ref-
erence entities’ stock returns, trading volume, and bid-
ask spreads from Center for Research in Security Prices
(CRSP); assets and liabilities from Compustat; and the
transaction prices of bonds issued by the reference enti-
ties from TRACE. We also obtain European reference en-
9
This is because, before the Big Bang, some contracts on distressed
firms were already traded with a fixed coupon of 500 bps and upfront
payments (Markit, 2009a). The cutoff of 750 bps for the North American
samples is chosen to mitigate the impact of distressed firms. This filter re-
moves about 5.5% of total observations from the CMA sample and 5% from
the Markit sample. Since European CDSs have a fixed coupon of 10 0 0 bps,
we choose a cutoff of 10 0 0 bps for the European samples.
It is worth noting that the bid-ask spreads are higher in the Markit
sample than in the CMA sample because the CMA sample includes the
precrisis period, when the CDS spread levels were relatively low and the
trading volume was relatively large.
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6 X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx

Table 1
Summary statistics.
Panel A provides the summary statistics of the North American CMA sample on 634 North
American companies from January 1, 2004 to September 30, 2010. Panel B provides the sum-
mary statistics of the North American Markit sample on 765 North American companies from
April 1, 2010 to October 19, 2016. Panel C provides the summary statistics of the European CMA
sample on 423 European companies from January 1, 2004 to September 30, 2010. Panel D pro-
vides the summary statistics of the European Markit sample on 547 European companies from
April 1, 2010 to October 19, 2016. BidAsk is the difference between the bid and ask quotes of the
CDS spreads, denominated in bps. S is the midpoint of the bid and ask quotes of the CDS spreads,
in bps. DIS is defined in Eq. (1), denominated in percentages. LOIS is the three-month Libor rate
minus the three-month OIS rate, denoted in percentages, and is from Bloomberg. Leverage is the
ratio of total liability to total asset. Stock volatility is the two-week rolling standard deviation of
stock returns. Log(stock volume) is the logarithm of the daily stock trading volume, in number of
shares, of the reference entity. Stock bid-ask spread is the ask price minus the bid price divided
by the midpoint of the bid and ask prices of the stock price of the reference entity, denoted
in bps. Both Stock volume and Stock bid-ask spread are from CRSP. Log(bond volume) is the loga-
rithm of the daily trading volume (denominated in dollars in face value) of the reference entity’s
bonds, according to TRACE. Log(bond Amihud) is the logarithm of the Amihud (2002) measure
calculated for the reference entity’s bonds. Fee is the size of the upfront payment provided by
Markit, expressed in the percentage of the notional value. LOIS Euro is the spread between the
three-month Euro Libor rate and the three-month Euro OIS rate, denoted in percentages.

Panel A: North American CMA sample (January 1, 2004 to September 30, 2010)

Variable N Mean St dev 1% Median 99%

BidAsk (bps) 633,977 9.61 8.28 2.00 5.30 40.00

S (bps) 633,977 136.69 152.80 9.00 71.20 681.22
DIS (%) 633,977 0.67 0.45 0.02 0.62 1.98
LOIS (%) 633,975 0.32 0.45 0.05 0.11 2.53
Leverage 579,937 0.67 0.18 0.32 0.66 1.12
Stock volatility 543,649 0.02 0.02 0.00 0.02 0.08
Log(stock volume) 541,845 14.70 1.40 10.64 14.70 17.82
Stock bid-ask spread (bps) 542,578 9.97 22.55 0.00 5.43 79.09
Log(bond volume) 393,615 15.01 2.14 9.62 15.43 18.84
Log(bond Amihud) 393,615 -15.52 2.22 -22.43 -14.92 -12.00

Panel B: North American Markit sample (April 1, 2010 to October 19, 2016)

Variable N Mean Stdev 1% Median 99%

BidAsk (bps) 659,618 12.39 9.36 4.00 10.00 47.17

S (bps) 659,618 154.52 145.48 15.33 101.99 675.73
DIS (%) 659,618 0.88 0.92 0.01 0.57 4.09
Fee (%) 659,618 4.07 4.15 0.06 2.76 19.08
LOIS (%) 659,618 0.20 0.09 0.09 0.16 0.49
Leverage 422,882 0.68 0.18 0.36 0.65 1.29
Stock volatility 425,902 0.02 0.01 0.00 0.01 0.05
Log(stock volume) 425,382 14.71 1.41 9.62 14.78 17.60
Stock bid-ask spread (bps) 425,904 4.27 8.51 0.54 2.68 25.27
Log(bond volume) 416,762 14.90 2.16 9.39 15.29 18.83
Log(bond Amihud) 407,582 -15.61 1.71 -21.39 -15.28 -12.52

Panel C: European CMA sample (January 1, 2004 to September 30, 2010)

Variable N Mean Stdev 1% Median 99%

BidAsk (bps) 421,667 8.64 9.19 1.75 5.00 47.00

S (bps) 421,667 113.71 136.96 6.50 59.50 640.00
DIS (%) 421,667 0.37 0.47 0.00 0.19 1.95
LOIS Euro (%) 421,667 0.29 0.36 0.03 0.07 1.69
Stock volatility 359,428 0.02 0.21 0.00 0.01 0.09
Stock bid-ask spread (bps) 361,557 111.92 190.08 0.00 38.65 596.42
Log(stock volume) 361,557 3.94 3.51 0.00 3.01 11.24

Panel D: European Markit sample (April 1, 2010 to October 19, 2016)

Variable N Mean Stdev 1% Median 99%

BidAsk (bps) 480,117 12.57 9.80 3.50 10.00 50.00

S (bps) 480,117 156.66 137.89 25.75 104.65 667.75
DIS (%) 480,117 0.95 1.10 0.01 0.48 4.28
Fee (%) 480,117 4.42 5.14 0.05 2.35 21.12
LOIS Euro (%) 480,117 0.17 0.19 0.01 0.10 0.87
Stock volatility 328,415 0.02 0.57 0.00 0.02 0.07
Stock bid-ask spread (bps) 328,415 68.46 85.32 1.07 34.68 363.64
Log(stock volume) 333,468 4.36 3.37 0.00 3.70 11.68

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
JID: FINEC
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tities’ stock returns, trading volume, and bid-ask spreads
from Datastream. We construct two bond market liquidity
measures. The first is the Amihud (2002) measure, defined
 (2)
as 1/N N i=1 |ri |/vi , where N is the number of trades within
a given day and ri and vi are the percentage price change
and the dollar volume of the ith trade, respectively. If a
firm has multiple bonds, we aggregate the Amihud mea-
sures of all bonds issued by the same firm (identified by
its six-digit CUSIP number) by averaging their daily val-
ues. The second measure is the trading volume aggregated
across the daily trading volumes of all bonds issued by
the same firm. To mitigate the impact of outliers, all con-
tinuous variables are winsorized at the 1st and 99th per-
centiles.
2.2.2. Upfront funding cost measures
For contracts with a given maturity, the upfront funding
cost has two components: the size of the upfront fee and
the funding cost of each unit of payment. As illustrated in
earlier examples, after the CDS Big Bang, the size of the
upfront fee is determined by the distance between the CDS
spread and the coupon rate. In our CMA sample, we cannot
directly observe the upfront fee size or the coupon rate,
but we can infer them from the CDS spread. We can infer
the coupon rate (i.e., 100 or 500 bps) since it is usually
chosen to be closer to the CDS spread.11 Hence, for each
CDS contract i on day t, we construct a variable DISi, t :
DISi,t = min (|Si,t − 100|, |Si,t − 500| ), (1)
where Si, t is the CDS spread of contract i on day t. That is,
DIS is the minimum distance between the CDS spread and
the two possible coupon rates. In our Markit sample, we
can observe the actual coupon Ci, t used for contract i on
day t. Hence, we do not have to use the approximate defi-
nition of the upfront fee size in Eq. (1), and we can simply
define DISi, t as the distance between the CDS spread and
the actual coupon rate.
For a given maturity of CDS contracts, DIS can be used
as a proxy for the upfront fee size. After the CDS Big
Bang, for CDS contracts with the same maturity, the size of
the upfront fee is approximately linear in DIS.12 The higher
the DIS is, the larger the upfront fee. To measure the fund-
ing cost of each unit of payment, we follow Garleanu and
Pedersen (2011) and use the three-month Libor-OIS spread,
which is the three-month Libor rate minus the three-
month overnight indexed swap (OIS) rate. The Libor rate is
the uncollateralized borrowing rate of large banks, and the
OIS rate is often considered the risk-free rate. Hence, this
spread is a proxy for the price of funding for large insti-
tutional investors. From Bloomberg, we obtain daily close
values of Libor-OIS spreads, which have significant varia-
tions in our sample period, ranging from under 5 bps to
over 250 bps during the recent financial crisis.
11
For example, according to our Markit sample, where the coupon rate
is directly observable, the “primary coupon rate” is chosen as the one that
is closest to the CDS spread for about 92% of the observations.
12
The nonlinearity is caused by the possibility of default of the ref-
erence entity, but the effect is minor for our sample, where the credit
spread is below 750 bps.
Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
[m3Gdc;August 22, 2020;6:7]
7
For the five-year CDS contracts, we define the upfront
funding cost as
Fi,t = DISi,t × LOISt ,
where Fi, t is the upfront funding cost for the five-year CDS
contract i at day t and LOISt is the three-month Libor-OIS
spread on day t.
3. The relation between CDS funding costs and market
liquidity
We first provide visual evidence that the decrease in
aggregate market liquidity is smaller for CDS contracts
with larger upfront funding costs after the Big Bang. We
then establish the causal link between funding costs and
market liquidity using regression analysis.
3.1. Visual evidence
The goal of the CDS Big Bang is to standardize CDS con-
tracts and to improve market liquidity (JPMorgan, 2009).
Therefore, it is expected that the aggregate market liq-
uidity should improve. Consistent with this prediction,
Fig. 1 shows that the average bid-ask spread decreased af-
ter the Big Bang. We conduct t-tests of the difference in
the average bid-ask spread six months before and after the
Big Bang and find that the difference is -2.97 bps and is
statistically significant from zero at the 1% level.
The upfront funding costs arising from the fixed
coupons are expected to affect the market liquidity of
firms with different levels of upfront payments. Fig. 2 plots
the average change in bid-ask spreads (compared to the
pre-Big-Bang level) for firms with high upfront costs ver-
sus firms with low upfront costs. As seen in the plot, the
rate of decline for the high upfront firms is less than the
low upfront firms. This figure summarizes our main find-
ing that liquidity improvement is smaller for CDS contracts
with larger upfront fees. The remainder of the section ex-
pands our analysis more thoroughly around this point us-
ing regression analysis.
3.2. The upfront funding cost effect on bid-ask spreads
around the CDS Big Bang
After the CDS Big Bang, trading single-name CDS re-
quires upfront payments, which increase the capital re-
quirement of trading and the cost of market making for
dealers.13 Therefore, although overall market liquidity im-
proves after the Big Bang, it is expected that the improve-
ment is less for contracts that require large upfront pay-
ments. In other words, our main empirical prediction is
that, controlling for other effects, CDS bid-ask spreads are
larger for contracts with larger upfront fees after the CDS
Big Bang. To test this prediction, we estimate the following
regression specification:
BidAski,t = b1 × Fi,t + b2 × Fi,t × BBt + γ1 × Xi,t
13
As also theoretically formulated in Andersen et al. (2019), fund-
ing the upfront payments is costly to dealers, which leads to higher
bid-ask spreads. In addition, as in Garleanu and Pedersen (2011) and
Shen et al. (2014), capital-constrained investors are reluctant to trade as-
sets that are capital intensive.
JID: FINEC
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8 X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx

Fig. 2. Average change in bid-ask spreads compared to the pre-Big-Bang level for firms with different upfronts. This figure plots the average change in
bid-ask spreads compared to the pre-Big-Bang level for firms with high upfront costs versus firms with low upfront costs. For each firm, the change in
bid-ask spreads is calculated as the difference between the bid-ask spread and its pre-Big-Bang level, which is its average bid-ask spread over the pre-Big
Bang period from October 2008 to March 2009. We divide the sample into two subsamples by the median of upfront funding costs, and we calculate the
average change in bid-ask spreads for each subsample. The dashed line is for firms with high upfront costs, and the solid line is for firms with low upfront
costs. The vertical dashed line indicates the effective date, April 8, 2009, of the Big Bang.

+ γ2 × Xi,t × BBt + ui + vt + i,t , (3) age LOISt is 32 bps. Note that both DISi, t and LOISt are
expressed in percentage points when calculating Fi, t , and
where BidAski, t is the bid-ask spread for trading CDS con-
therefore Fi,t = 1 (percent ) × 0.32 (percent ). Taken to-
tract i on day t, BBt is a dummy variable that is one if the
gether, we have the following estimate: b2 × Fi,t × BBt =
date t is later than April 8, 2009 and zero otherwise, Xi, t
2.39 × (1 × 0.32) × 1 = 0.76 bps. To put the magnitude in
is the set of control variables described in Section 2.2, ui
perspective, the mean and median bid-ask spreads in the
is the firm fixed effect, and vt is the day fixed effect. The
full sample are 9.61 and 5.30 bps, respectively. That is, the
results are reported in Table 2.14
bid-ask spread increases by about 8% (14%) relative to the
We first run two panel regressions of CDS bid-ask
sample mean (median) bid-ask spread.
spreads on F, one for the pre-Big-Bang sample and the
Moreover, to assess how funding liquidity impacts mar-
other for the post-Big-Bang sample. As shown in columns
ket liquidity for the average contract in a normal market
(1) and (2) in Table 2, the coefficient of F is 0.62 (t=5.59)
environment, we also calculate additional key statistics af-
in the pre-Big-Bang sample, and it increases substantially
ter excluding observations in the crisis period (20 08–20 09)
to 2.90 (t=7.10) in the post-Big-Bang sample. The differ-
from our sample. In the noncrisis period, the mean and
ence between these two coefficients identifies the funding
median of DIS in are 67 bps and 64 bps, respectively, and
effect from the CDS Big Bang. This identification strategy is
the mean and median bid-ask spreads are 8.10 bps and
formally estimated in the regression in column (3), which
5.0 bps, respectively. Therefore, after excluding the crisis
is based on the entire sample and includes the interaction
period, the increase in the bid-ask spread for a contract
term F × BB. The estimate of the interaction coefficient is
with the mean upfront payment is 0.51 bps (2.39 × (0.67
2.39 (t=5.62), indicating that the CDS bid-ask spread be-
× 0.32) × 1=0.51), which is about 6% relative to the mean
comes more correlated with F after the CDS Big Bang.
bid-ask spread of 8.10 bps in the noncrisis period. Simi-
The effect of upfront funding costs on bid-ask spreads
larly, the increase in the bid-ask spread for a contract with
is economically significant. To demonstrate how to map
the median upfront payment is 0.49 bps (2.39 × (0.64 ×
our point estimate and the average OIS spread to the in-
0.32) × 1=0.49), which is about 10% relative to the median
crease in the bid-ask spread post-Big Bang, let’s consider a
bid-ask spread of 5.0 bps in the noncrisis period.
contract with DIS = 100 bps; i.e., the contract is 100 bps
In Online Appendix B, we also use a measure of upfront
away from the fixed coupon (e.g., a 200 bps fair-value
funding costs calculated by the ISDA CDS standard model
spread relative to the 100 bps fixed coupon). The increase
and find similar results.15
in the bid-ask spread post-Big Bang is given by the in-
Finally, we repeat the regression in Eq. (3) using the
teraction term b2 × Fi, t × BBt . The point estimate of b2 is
CDS Small Bang. The results are presented in columns (4)
2.39 in column (3) of Table 2, BBt is equal to one post-
to (6) of Table 2. In column (6), the coefficient for the
Big Bang, and Fi, t is defined as DISi, t × LOISt . The aver-
interaction term F × SB is 3.58 and is statistically signif-

14
For brevity, the coefficients (γ 2 ) for interaction terms between BB and
control variables are not reported in Table 2; they are instead reported in
the Online Appendix A. Since most of the coefficients of γ 2 are insignif-
icant, we drop the term Xi, t × BBt in the later regressions for parsimony
purposes.
15
After the CDS Big Bang, market participants follow a standard proce-
dure, the ISDA CDS Standard Model, to convert coupon rates and upfront
fees into the CDS spread or vice versa. The details of the model are avail-
able from http://www.cdsmodel.com/cdsmodel/.

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
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Table 2
Effects of upfront funding costs around the CDS Big Bang and Small Bang.
This table reports the effects of upfront funding costs on CDS bid-ask spreads. We estimate the
funding cost effect using the CDS Big Bang based on the North American CMA sample (January
1, 2004 to September 30, 2010) in columns (1) to (3) and using the CDS Small Bang based on
the European CMA sample (January 1, 2004 to September 30, 2010) in columns (4) to (6). The
regression specification for the CDS Big Bang is

BidAski,t = b1 × Fi,t + b2 × Fi,t × BBt + γ1 × Xi,t + γ2 × Xi,t × BBt + ui + vt + i,t ,

where BidAski, t is the bid-ask spread for trading CDS contract i on day t, Fi, t is the upfront funding
cost for trading CDS contract i with five-year maturity on day t defined in Eq. (2), BBt is a dummy
variable that is one if the date t is later than April 8, 2009 and zero otherwise, Xi, t is the set
of control variables described in Section 2.2, ui is the firm fixed effect, and vt is the day fixed
effect. Interaction terms (γ 2 ) between BBt and control variables are not reported in the table. The
regression specification for the CDS Small Bang is similarly defined with BBt being replaced by
SBt , where SBt is a dummy variable that is one if the date t is later than June 20, 2009. Numbers
in parentheses are t-statistics based on standard errors that are clustered by firm and time. ∗ , ∗ ∗ ,
and ∗ ∗ ∗ denote statistical significance at the 10%, 5%, and 1% level, respectively.

Big Bang Small Bang

(1) (2) (3) (4) (5) (6)

Pre-BB Post-BB Overall Pre-SB Post-SB Overall

F 0.62∗ ∗ ∗ 2.90∗ ∗ ∗ 0.65∗ ∗ ∗ 1.95∗ ∗ ∗ 4.10∗ ∗ ∗ 1.81∗ ∗ ∗

(5.59) (7.10) (5.96) (6.69) (5.23) (6.35)
F × BB 2.39∗ ∗ ∗
(5.62)
F × SB 3.58∗ ∗ ∗
(3.43)
S 0.03∗ ∗ ∗ 0.03∗ ∗ ∗ 0.03∗ ∗ ∗ 0.04∗ ∗ ∗ 0.04∗ ∗ ∗ 0.04∗ ∗ ∗
(28.54) (20.01) (29.29) (26.74) (12.95) (26.77)
Log(stock volume) 0.05 0.01 -0.01 0.06 -0.00 0.03
(0.81) (0.08) (-0.23) (0.68) (-0.04) (0.39)
Stock bid-ask spread 0.00 -0.00 0.00 1.98 2.90 -1.30
(0.71) (-0.28) (0.62) (0.45) (0.65) (-0.27)
Stock volatility 18.69∗ ∗ ∗ 26.07∗ ∗ ∗ 20.82∗ ∗ ∗ 9.90∗ 13.77∗ ∗ ∗ 10.24∗
(3.96) (4.90) (4.37) (1.91) (3.16) (1.94)
Log(bond volume) -0.02 -0.02∗ -0.02
(-1.32) (-1.83) (-1.23)
Log(bond Amihud) 0.01 -0.04∗ ∗ ∗ 0.01
(0.89) (-2.77) (0.86)
Leverage -2.96∗ ∗ 0.69 -2.25∗ ∗
(-2.53) (0.20) (-2.33)

Observations 252,447 102,211 354,664 275,098 84,325 359,425

R-squared 0.82 0.88 0.84 0.85 0.90 0.85
Number of firms 450 387 459 356 321 371

icant (t=3.43). This result provides additional supporting
evidence for our main finding.
3.3. Analysis using variation across maturities
In this section, we analyze CDS contracts with differ-
ent maturities to provide a more compelling analysis of
the effects of upfront funding costs on market liquidity. We
collect additional data of one-year, three-year, seven-year,
and ten-year CDS contracts from Datastream to supple-
ment the five-year data, and apply the same filters as those
in Section 2.2. Since an upfront payment is the present
value of risky payments that is equal to the difference be-
tween the CDS spread and the fixed coupon during the life
of a CDS contract, the size of the upfront payment depends
on the maturity of the contract.
It is worth noting that the size of the upfront payment
also depends on the shape of the term structure of CDS
spreads. CDS contracts with different maturities for the
same firm can still have different CDS spreads. For exam-
ple, the CDS spread term structure is usually upward slop-
ing. Therefore, we also include the levels of CDS spreads
for different maturities as control variables in the analysis.
Because the upfront funding cost is nearly proportional
to the maturity of CDS contracts, we extend the definition
of the upfront funding cost to different maturities as fol-
lows: Fi,m,t = DISi,t × LOISt × Mat urit ym , where Fi, m, t is the
upfront funding cost for contract i with maturity m at day
t and Maturitym is the term to maturity of CDS contracts
with maturity m, expressed in units of five years (so that
it is consistent with the definition for five-year contracts in
Eq. (2)). We then repeat our difference-in-difference anal-
ysis using variation across maturities but within firms. We
consider the following regression specification:

BidAski,m,t = b1 × Fi,m,t + b2 × Fi,m,t × BBt + γk
k∈M
× Si,k,t × 1k=m + αi,t + ui,m + i,m,t , (4)
where BidAski, m, t is the bid-ask spread for trading CDS
contract i with maturity m on day t, m is the maturity of

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
JID: FINEC
ARTICLE IN PRESS
10 X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx
CDS contracts in years, Fi, m, t is the upfront funding cost
for contract i with maturity m at day t, BBt is a dummy
variable that is one if the date t is later than April 8, 2009
and zero otherwise, M is the set of CDS maturities (i.e.,
one-year, three-year, five-year, seven-year, and ten-year),
Si, k, t is the CDS spread for contract i with maturity k on
day t, 1k=m is an indicator function, α i, t is a firm-by-date
fixed effect, and ui, m is a firm-by-maturity fixed effect.
The firm-by-date fixed effect controls for any unobserved
heterogeneity across firms at each point in time, and the
firm-by-maturity fixed effect controls for any unobserved
factors (other than upfront funding costs) affecting bid-ask
spreads across maturities for each firm.
To remove outliers of thinly traded non-five-year CDSs,
we require observations with relative bid-ask spreads (bid-
ask spread/CDS spread) smaller than 20%. Furthermore,
when a firm is close to default, its short-term CDS spreads
could be higher than long-term CDS spreads. When this
happens, informed traders prefer to trade short-term con-
tracts. CDS dealers thus tend to set large bid-ask spreads
for short-term contracts. Therefore, to mitigate the impact
of this dramatic widening of bid-ask spreads for short-
term contracts due to informed trading, we exclude obser-
vations when the one-year CDS spread is larger than the
five-year CDS spread.
The regression results are presented in Table 3. Column
(1) reports the results based on the CDS Big Bang. The co-
efficient of the interaction term F × BB is 2.36 and is statis-
tically significant (t=4.00). It is noteworthy that the mag-
nitude of this estimate is similar to the estimate of 2.39
in our main results in Table 2, indicating that the matu-
rity analysis and the main analysis deliver similar point es-
timates. The consistency between the two analyses lends
credence to the estimate of causal elasticity between fund-
ing liquidity and market liquidity.
We next conduct an additional analysis using European
CDS contracts with different maturities. We collect addi-
tional CDS data of one-year, three-year, seven-year, and
ten-year European CDS contracts from Datastream and ap-
ply the same filters as those for the North American con-
tracts. We repeat the exercise and the results are reported
in column (2) of Table 3. The coefficient of the interaction
F × SB is 2.01 and is statistically significant (t=2.19).
4. Robustness
In this section, we provide robustness around the causal
link between funding liquidity and market liquidity. More
specifically, we first explore the heterogenous effects based
on firm size and riskiness. Next, we investigate the effects
of central clearing and the exit of Deutsche Bank from the
CDS market. In addition, we conduct placebo tests using
bond and stock liquidity and placebo tests based on event
dates. Finally, we analyze the asymmetric effects of upfront
funding costs and conduct additional analyses.
4.1. Heterogeneous effects based on size and rating
The market liquidity of all assets depends on traders’
funding liquidity. When there is a negative shock to
traders’ funding, traders reduce trading by a greater
Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
[m3Gdc;August 22, 2020;6:7]
Table 3
Funding effects for contracts with different maturities.
This table reports the estimations of the following regression
model:

BidAski,m,t = b1 × Fi,m,t + b2 × Fi,m,t × BBt + γk × Si,k,t × 1k=m
k∈M
+ αi,t + ui,m + i,m,t ,
where BidAski, m, t is the bid-ask spread for trading CDS contract
i with maturity m on day t, Fi, m, t is the upfront funding cost for
trading CDS contract i with maturity m on day t as defined in
Section 3.3, m is the maturity of CDS contracts, BBt is a dummy
variable that is one if the date t is later than April 8, 2009 and
zero otherwise, M is the set of CDS maturities (i.e., 1Y, 3Y, 5Y, 7Y,
and 10Y), Si, m, t is the CDS spread for CDS contract i with matu-
rity m on day t, 1k=m is an indicator function, α i, t is a firm-by-date
fixed effect, and ui, m is a firm-by-maturity fixed effect. The regres-
sion specification for the CDS Small Bang is similarly defined with
BBt being replaced by SBt , where SBt is a dummy variable that is
one if the date t is later than June 20, 2009 and zero otherwise.
The estimation in column (1) employs the CDS Big Bang based
on the North American CMA sample (January 1, 2004 to Septem-
ber 30, 2010), and the estimation in column (2) employs the CDS
Small Bang based on the European CMA sample (January 1, 2004 to
September 30, 2010). Numbers in parentheses are t-statistics based
on standard errors that are clustered by firm and time. ∗ , ∗ ∗ , and ∗ ∗ ∗
denote statistical significance at the 10%, 5%, and 1% level, respec-
tively.
(1) (2)
Big Bang Small Bang
F 0.33 -0.57
(1.40) (-1.30)
F × BB 2.36∗ ∗ ∗
(4.00)
F × SB 2.01∗ ∗
(2.19)
Control Included Included
Observations 535,478 220,784
R-squared 0.932 0.940
Number of firms 506 309
amount on riskier and less liquid assets, and therefore
there is a greater reduction in market liquidity for riskier
and less liquid assets (Brunnermeier and Pedersen, 2009).
In our context, to the extent that CDS contracts with lower
credit ratings and smaller reference entities are riskier and
less liquid, we predict that the funding effect is stronger
for CDS contracts on riskier and smaller reference entities.
To test this prediction, we construct a dummy vari-
able Smalli, t , which is one if the reference entity i’s asset
value is below the median at day t and zero otherwise.
Similarly, we define a dummy variable Speculativei, t , which
is one if the reference entity i’s credit rating at day t is be-
low BBB and zero otherwise.
We then run the difference-in-difference regression
with an additional term, F × BB × Small, in the following
specification:
BidAski,t = b1 × Fi,t + b2 × Fi,t × BBt + b3 × Fi,t × BBt
× Smal li,t + γ × Xi,t + ui + vt + i,t . (5)
The regression results are reported in Table 4. As shown
in column (1), the coefficient of this term is 1.40 (t=2.47),
suggesting that the funding effect is stronger for CDS
contracts on smaller entities. Note that the coefficient for
F × BB is 2.15 (t=4.38), implying that the funding effect for
CDS contracts on smaller reference entities is around 65%
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X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx 11

Table 4
Heterogeneous effects based on size and rating and placebo tests using bond and stock liquidity.
This table reports the effects of upfront funding costs on CDS bid-ask spreads for firms with different sizes and credit
ratings and placebo tests using bond and stock liquidity. The specification in column (1) is

BidAski,t = b1 × Fi,t + b2 × Fi,t × BBt + b3 × Fi,t × BBt × Smal li,t + γ × Xi,t + ui + vt + i,t ,

where BidAski, t is the bid-ask spread for trading CDS contract i on day t, Fi, t is the upfront funding cost for trading CDS
contract i with five-year maturity on day t defined in Eq. (2), BBt is a dummy variable that is one if the date t is later than
April 8, 2009 and zero otherwise, Smalli, t is a dummy variable that is one if the reference entity i’s asset value is below
the median at day t and zero otherwise, Xi, t is the set of control variables described in Section 2.2, ui is the firm fixed
effect, and vt is the day fixed effect. The regression specification in column (2) is similarly defined with Smalli, t replaced
by Speculativei, t , which is a dummy variable that is one if the reference entity i’s credit rating at day t is below BBB and
zero otherwise. The regression specifications in columns (3) and (4) for the Small Bang are similarly defined with BBt being
replaced by SBt , where SBt is a dummy variable that is one if the date t is later than June 20, 2009 and zero otherwise. For
CDS Big Bang, we use the North American CMA sample (January 1, 2004 to September 30, 2010), and for CDS Small Bang,
we use the European CMA sample (January 1, 2004 to September 30, 2010). The regression specification for the placebo
test using bond liquidity in column (5) is

BidAskPbond,i,t = b1 × Fi,t + b2 × Fi,t × BBt + γ × Xi,t + ui + vt + i,t ,

where BidAskPbond,i,t is the bond bid-ask spread for reference entity i on day t as defined in Eq. (9). The regression specifi-
cation in column (6) is similarly defined with BidAskPbond,i,t replaced by BidAskPstock,i,t , which is the stock bid-ask spread for
reference entity i on day t as defined in Eq. (10). The specification for a difference-in-difference test using bond and CDS
liquidity in column (7) is

BidAska,i,t = αi,t + ui,a + b1 × Fi,t × T ypea,i + b2 × Fi,t × T reateda,i,t + i,t ,

where a ∈ {CDS, Bond} denotes whether the bid-ask spread is in the CDS market or the bond market, α i, t is a firm-by-date
fixed effect, ui, a is a firm-by-type fixed effect, Typea, i is a dummy variable that is one for CDS contracts and zero for bonds,
and Treateda, i, t is a dummy variable that is one for CDS contracts after the CDS Big Bang and zero for all other contracts.
Numbers in parentheses are t-statistics based on standard errors that are clustered by firm and time. ∗ , ∗ ∗ , and ∗ ∗ ∗ denote
statistical significance at the 10%, 5%, and 1% level, respectively.

Big Bang Small Bang Placebo tests using bond and stock
liquidity around Big Bang

(1) (2) (3) (4) (5) (6) (7)

Firm size Credit rating Firm size Credit rating Bond Stock CDS-bond

F 0.54∗ ∗ ∗ 0.54∗ ∗ ∗ 1.90∗ ∗ ∗ 1.91∗ ∗ ∗ -1.80∗ -0.12

(5.35) (5.37) (7.94) (7.97) (-1.74) (-1.00)
F × BB 2.15∗ ∗ ∗ 1.98∗ ∗ ∗ -1.30 -0.68
(4.38) (4.53) (-0.36) (-1.54)
F × BB × Small 1.40∗ ∗
(2.47)
F × BB × Speculative 1.68∗ ∗ ∗
(3.02)
F × SB 1.61 1.11
(1.52) (0.95)
F × SB × Small 3.77∗ ∗
(2.44)
F × SB × Speculative 3.11∗ ∗
(2.01)
F × Type 3.08∗ ∗ ∗
(8.13)
F × Treated 2.87∗ ∗ ∗
(3.28)
Control Included Included Included Included Included Included FE
Observations 354,664 354,664 359,425 359,425 268,877 354,667 766,126
R-squared 0.84 0.84 0.85 0.84 0.39 0.31 0.76
Number of firms 459 459 371 371 370 456 415

(1.40/2.15=0.65) stronger. Similarly, in column (2), where
we use F × BB × Speculative instead of F × BB × Small in the
regression, the coefficient for F × BB × Speculative is 1.68
(t=3.02), and the coefficient for F × BB is 1.98 (t=4.53), im-
plying that the funding effect for CDS contracts on entities
with speculative ratings is around 85% (1.68/1.98=0.85)
stronger.
Next, we repeat the analysis using the European CMA
sample and report the results in columns (3) and (4)
in Table 4. The coefficients of the interaction terms
F × BB × Small and F × BB × Speculative are positive and sta-
tistically significant, suggesting that the funding effect is
stronger for riskier or less liquid CDSs.
4.2. Central clearing and the exit of Deutsche Bank from the
CDS market
4.2.1. Central clearing
Central clearing is one of the main reasons for the stan-
dardization of CDS contracts. With central clearing, CDS

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
JID: FINEC
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12 X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx
traders face a single counterparty, the CCP. Hence, if a CDS
trader has multiple positions with the same CCP, he or she
can effectively net his or her positions. This netting benefit
can be large for CDS dealers since they often have signif-
icant offsetting positions. Hence, central clearing can par-
tially mitigate the upfront funding effect.
ICECC started to clear single-name CDS contracts in De-
cember 2009, which is about eight months after the CDS
Big Bang. We obtain the initial dates for central clearing
for firms in our sample from the historical circulars is-
sued by ICECC from their official website (https://www.
theice.com/clear-credit/circulars).16 Since our North Amer-
ican CMA sample ends in September 2010, it has limited
coverage of central clearing. Our North American Markit
sample, which ends in October 2016, has better coverage
of central clearing. Therefore, we use the Markit sample to
conduct the analysis of central clearing. To avoid the con-
founding effect of Deutsche Bank’s exit in the CDS market
around the end of 2014, we choose the sample period from
April 1, 2010 to September 14, 2014.
It is worth noting that CDS contracts may not be
randomly selected for central clearing. To address this
concern, we follow Loon and Zhong’s (2014) approach of
modeling the selection for central clearing. We estimate
a probit model and use the same set of explanatory
variables used by Loon and Zhong (2014), including liq-
uidity, CDS outstanding notional, credit rating, and firm
characteristics. The regression results of the probit models
are reported in Online Appendix C and show that the
explanatory variables can explain the selection of central
clearing reasonably well.
After establishing the selection model of central clear-
ing, we construct a propensity score-matched sample us-
ing the probit model. For each cleared firm, we choose one
matched noncleared firm with the closest score. We then
run the following difference-in-difference regression using
the matched sample:
BidAski,t = b1 × Fi,t + b2 × Fi,t × Cleari,t + b3 × Cleari,t
+ γ × Xi,t + ui + vt + i,t , (6)
where the upfront funding cost Fi, t is defined in
Eq. (2) and Cleari, t is a dummy variable that is equal to one
if the date is later than the initial clearing date t for a CDS
contract i and zero otherwise.
The results in column (1) of Table 5 show that the in-
teraction coefficient is −2.77 and is statistically significant
(t=2.75). The effect is also economically significant. For ex-
ample, in the Markit sample (Panel B in Table 1) that is
used for central clearing analysis, the average DIS and LOIS
are 0.88% and 0.2%, respectively. Therefore, the average F
is DIS × LOIS=0.88 × 0.2=0.18. Hence, our estimate implies
that, on average, due to the improvement in netting, cen-
tral clearing reduces the bid-ask spread by around 0.5 bps
(2.77 × 0.18), which is about 4% (5%) relative to the sample
mean (median) of bid-ask spreads of 12.39 (10.00) bps in
the Markit sample (Panel B of Table 1).
16
For those firms whose circulars are no longer available, we use the
historical initial clearing dates from www.theice.com/publicdocs/ice_trust/
ICE_Trust_Contract_Roster.xls.
Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
[m3Gdc;August 22, 2020;6:7]
Next, we repeat our analysis of central clearing us-
ing the European Markit sample. Central clearing of Eu-
ropean CDSs started on December 14, 2009. We obtain
the initial dates for central clearing for firms in our sam-
ple from the historical circulars issued by ICE Clear Eu-
rope from their official website (https://www.theice.com/
clear-europe/circulars). To avoid the impact of Deutsche
Bank’s exit in the single-name CDS market on the bid-
ask spread, we use the sample period from April 1, 2010
to September 14, 2014. To address endogeneity concerns,
we repeat the selection model of central clearing for Euro-
pean CDSs and construct a propensity score-matched sam-
ple. The regression results based on the propensity score-
matched sample are depicted in column (2) of Table 5. The
coefficient of F × Clear is -2.88 and is statistically significant
(t=2.37), consistent with the results in column (1).
In summary, we find that central clearing can help to
partially alleviate the funding cost effect. This finding also
indicates the importance of implementing central clearing
after the standardization of CDS contracts.
4.2.2. The exit of Deutsche Bank from the CDS market
In late 2014, Deutsche Bank, a major CDS dealer, de-
cided to exit the single-name CDS market, creating a major
shock to the aggregate market-making capacity in the mar-
ket. As shown in Brunnermeier and Pedersen (2009), the
funding effect is stronger when traders are closer to their
capital constraints. The exit of Deutsche Bank reduces deal-
ers’ aggregate market-making capacity, and thus dealers
are closer to their funding constraints. Hence, we expect
the funding effect to be stronger after the exit of Deutsche
Bank.
Deutsche Bank’s exit from the CDS market has been a
gradual process. Although its exit was reported in the me-
dia on November 17, 2014, the bank reportedly sold a port-
folio of CDSs with a notional value of nearly $250 billion to
Citibank in September 2014.17 Hence, we consider two dif-
ferent event dates, September 15, 2014 and November 17,
2014. Specifically, we define a time dummy variable, DB,
which is equal to one after the exit event and zero oth-
erwise. Since the central clearing of CDS contracts started
in December 2009, we also control for the effect of central
clearing by including an interaction term, F × Clear, and by
using the propensity score-matched samples constructed
in Section 4.2.1. We regress the bid-ask spread on the in-
teraction term F × DB using the following specification:
BidAski,t = b1 × Fi,t + b2 × Fi,t × DBt + b3 × Fi,t × Cleari,t
+ b4 × Cleari,t + γ × Xi,t + ui + vt + i,t . (7)
The results are reported in columns (3) and (4) of
Table 5. As shown in column (3), where the exit event
time is set as September 15, 2014, the interaction coef-
ficient is 4.73 (t=3.40). This result is consistent with our
prediction that the exit of Deutsche Bank from the CDS
market reduces the aggregate market-making capital, and
hence the market liquidity becomes more sensitive to the
17
For more details, see Devasabai, 2015. Citi buys $250bn
Deutsche Bank single-name CDS portfolio. Risk.net, Available at
https://www.risk.net/derivatives/credit-derivatives/2388970/citi-buys-
250bn- deutsche- bank- single- name- cds- portfolio.
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X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx 13

Table 5
Central clearing and Deutsche Bank’s exit from the CDS market.
This table reports the effects of central clearing and Deutsche Bank’s exit from the CDS market on CDS bid-
ask spreads. In columns (1) and (2), the regression has the following specification:

BidAski,t = b1 × Fi,t + b2 × Fi,t × Cleari,t + b3 × Cleari,t + γ × Xi,t + ui + vt + i,t ,

where BidAski, t is the bid-ask spread for trading CDS contract i on day t, Fi, t is the upfront funding cost for
trading CDS contract i with five-year maturity on day t defined in Eq. (2), and Cleari, t is a dummy variable,
which is equal to one if CDS contract i is centrally cleared at day t and zero otherwise. Xi, t is the set of control
variables described in Section 2.2, ui is the firm fixed effect, and vt is the day fixed effect. To control for
the selection of central clearing, we use probit models to fit the probability of central clearing and construct
matched samples using propensity scores derived from the probit model. Details of the probit models are
provided in Online Appendix C. The regression in column (1) is based on the propensity score-matched North
American Markit sample (April 1, 2010 to September 14, 2014), and the regression in column (2) is based on
the propensity score-matched European Markit sample (April 1, 2010 to September 14, 2014). In columns (3)
to (6), the regression specification is

BidAski,t = b1 × Fi,t + b2 × Fi,t × DBt + b3 × Fi,t × Cleari,t + b4 × Cleari,t + γ × Xi,t + ui + vt + i,t ,

where DBt is a dummy variable that is one if the date t is after Deutsche Bank exits the single-name CDS
market and zero otherwise. The regressions in columns (3) and (4) are based on the propensity score-matched
North American Markit sample (April 1, 2010 to October 19, 2016), and the regressions in columns (5) and (6)
are based on the propensity score-matched European Markit sample (April 1, 2010 to October 19, 2016). The
exit dates are set as September 15, 2014 and November 17, 2014 in columns (3)/(5) and (4)/(6), respectively.
Numbers in parentheses are t-statistics based on standard errors that are clustered by firm and time. ∗ , ∗ ∗ , and
∗∗∗
denote statistical significance at the 10%, 5%, and 1% level, respectively.

Central clearing Deutsche Bank exit

North American European North American European

9/15/2014 11/17/2014 9/15/2014 11/17/2014

(1) (2) (3) (4) (5) (6)

F 3.86∗ ∗ ∗ 7.26∗ ∗ ∗ 2.27∗ ∗ ∗ 2.32∗ ∗ ∗ 6.87∗ ∗ ∗ 6.88∗ ∗ ∗

(4.54) (9.88) (2.71) (2.72) (6.87) (6.88)
F × Clear -2.77∗ ∗ ∗ -2.88∗ ∗ -2.16∗ ∗ -2.11∗ ∗ -2.64∗ ∗ -2.64∗ ∗
(-2.75) (-2.37) (-2.41) (-2.38) (-2.22) (-2.22)
Clear -0.19 0.60 -0.02 0.00 0.89∗ 0.90∗
(-0.72) (1.12) (-0.04) (0.00) (1.73) (1.74)
F × DB 4.73∗ ∗ ∗ 4.64∗ ∗ ∗ 7.13∗ ∗ ∗ 7.02∗ ∗ ∗
(3.40) (3.39) (4.73) (4.60)
Control Included Included Included Included Included Included
Observations 203,527 197,233 284,346 284,346 270,850 270,850
R-squared 0.89 0.90 0.87 0.87 0.90 0.90
Number of firms 166 155 166 166 155 155

upfront funding cost. In our Markit sample, the average of
F is 0.18 bps; our estimate therefore implies that, on av-
erage, the Deutsche Bank exit increases the bid-ask spread
by about 0.9 bps (4.73 × 0.18), which is about 7% (9%) rel-
ative to the sample mean (median) of bid-ask spreads of
12.39 (10.00) bps in the Markit sample (Panel B of Table 1).
Our results highlight the importance of studying the influ-
ence of major dealers in the CDS market and are thus com-
plementary to the findings of Eisfeldt et al. (2018), who
study the effect of the removal of a dealer from the CDS
network, and Siriwardane (2019), who examines the effect
of dealer capital shocks on credit spreads.
Our results are robust to the choice of exit time. Col-
umn (4) reports the regression results when the exit date
is set to be November 17, 2014. The interaction coefficient
is similar to that in column (1) in both economic magni-
tude and statistical significance.
Finally, we repeat our analysis of the exit of Deutsche
Bank using the European Markit sample. We also con-
sider two different event dates: September 15, 2014 and
November 17, 2014. The regression results are reported in
columns (5) and (6) of Table 5. Since the central clearing
of European CDS contracts started in December 2009, we
again control for the effect of central clearing by includ-
ing the interaction term F × Clear. The coefficient of F × DB
is positive and statistically significant in both regressions.
4.3. Placebo tests
4.3.1. CDS liquidity against bond and stock liquidity
In this section, we first use bid-ask spreads in the cor-
porate bond market and the equity market as placebo tests.
Then, we run a difference-in-difference test using CDS liq-
uidity against bond market liquidity.
Since the standard coupon in the CDS Big Bang is only
applied to CDS contracts, we expect the effects of upfront
funding costs on the bond and stock bid-ask spreads of
the CDS firms to be insignificant. To test this expectation,
we collect bond bid and ask prices for our North Amer-
ican CMA sample from Bloomberg and run the following
regression:
BidAskPbond,i,t = b1 × Fi,t + b2 × Fi,t × BBt + γ
× Xi,t + ui + vt + i,t , (8)

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
JID: FINEC
ARTICLE IN PRESS
14 X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx
where BidAskPbond,i,t is the bond bid-ask spread defined as
 
P riceask
bond,i,t
− P ricebid
bond,i,t
BidAskPbond,i,t = . (9)
P ricemid
bond,i,t
Here, P riceask
bond,i,t
is the bond ask price, P ricebid
bond,i,t
is the
bond bid price, and P ricemid is the midpoint of the bond
bond,i,t
bid and ask prices. BidAskPbond,i,t
represents the transaction
cost of trading bond i at day t as a percentage of the bond
price. The regression results are presented in column (5) of
Table 4. Consistent with our expectations, the interaction
term F × BB is statistically insignificant.
Next, we repeat Eq. (8) with the stock bid-ask spread as
the dependent variable. The stock bid-ask spread is defined
as
 
P riceask
stock,i,t
− P ricebid
stock,i,t
BidAskPstock,i,t = ,
P ricemid
stock,i,t
where P riceask
stock,i,t
is the stock ask price, P ricebid
stock,i,t
is the
stock bid price, and P ricemid
stock,i,t
is the midpoint of the stock
bid and ask prices. BidAskPstock,i,t represents the transaction
cost of trading stock i at day t as a percentage of the stock
price. As expected, column (6) of Table 4 shows a similar
insignificant coefficient estimate of F × BB.
To provide further support to our main results, we next
perform a difference-in-difference analysis using CDS liq-
uidity against bond liquidity. To ensure that the same type
of liquidity measures is used for both CDS liquidity and
bond liquidity, we convert the bond prices into bond yields
and calculate the bid-ask spreads for bonds in terms of
bond yields. We then stack the data on CDS and bond bid-
ask spreads and run the following regression:
BidAska,i,t = αi,t + ui,a + b1 × Fi,t × T ypea,i + b2 × Fi,t
× T reateda,i.t + a,i,t , (11)
where a ∈ {CDS, Bond} denotes whether the bid-ask spread
is in the CDS market or the bond market, α i, t is a firm-by-
date fixed effect, ui, a is a firm-by-type fixed effect, Typea, i
is a dummy variable that is one for CDS contracts and zero
for bonds, and Treateda, i, t is a dummy variable that is one
for CDS contracts after the Big Bang and zero for all other
contracts. The firm-by-date fixed effect controls for any un-
observed heterogeneity across firms at each point in time,
and the firm-by-type fixed effect controls for any unob-
served factors (other than upfront funding costs) affecting
bid-ask spreads across the CDS and bond markets for each
firm.
This specification compares the gap between CDS-bond
liquidity before and after the Big-Bang, with the difference
being the causal impact that upfronts have on CDS mar-
ket liquidity after the Big Bang. The estimate of b2 is there-
fore expected to be comparable to our other estimates in
the previous sections. The regression results are reported
in column (7) of Table 4. The interaction term F × Treated
is 2.87 and is statistically significant (t=3.28). Indeed, the
estimate of 2.87 for b2 is comparable to the estimate of
our main result in Table 2. This result provides additional
evidence for the causal impact of upfronts on market liq-
uidity after the Big Bang.
Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
[m3Gdc;August 22, 2020;6:7]
4.3.2. Placebo tests on event dates
We also conduct placebo tests by using fictitious
dates for the CDS Big Bang and repeat the difference-in-
difference regression using the following specification:
BidAski,t =b1 × Fi,t + b2 × Fi,t × BBt +γ × Xi,t + ui + vt +i,t .
(12)
Specifically, we set two fictitious dates for the CDS Big
Bang: October 8, 2008 (six months before the actual date)
and October 8, 2009 (six months after the actual date). We
then rerun the above difference-in-difference tests using
one year of data around the two dates. In the first test,
the sample is from April 8, 2008 to April 7, 2009. Since
this entire sample period is before the policy change, we
expect the interaction coefficient to be insignificant. Sim-
ilarly, since the entire sample period in the second test
(from April 8, 2009 to April 7, 2010) is after the pol-
(10)
icy change, we expect the interaction coefficient to be in-
significant as well. Indeed, as shown in columns (1) and
(2) of Table 6, the estimates of the interaction coefficient
are −0.16 (t=0.72) and 0.79 (t=0.38) for the two placebo
tests. As a contrast, we also repeat our analysis using one
year of data around the actual date for the CDS Big Bang.
As shown in column (3), in sharp contrast to the two
placebo tests, the interaction coefficient is 1.84 (t=5.68).
The placebo tests provide support that our main empiri-
cal results are indeed attributed to the implementation of
the CDS Big Bang.
4.4. Additional results
4.4.1. Asymmetric effects of the upfront funding cost
In this section, we investigate whether or not there
are asymmetric effects of the upfront cost depending on
whether the buyer or seller must pay an upfront fee and
whether the dealers are, on average, net protection buyers
or sellers. Our predictions are as follows. For CDS contracts
for which protection buyers pay upfront, there is a higher
funding effect if the dealers are, on average, net protec-
tion buyers. Similarly, for CDS contracts for which protec-
tion sellers pay upfront, there is a higher funding effect if
the dealers are, on average, net protection sellers. To test
these predictions, we collect dealers’ aggregate net posi-
tion against customers from the TIW reports from DTCC
and construct a variable, DealerPayi, t , as follows:
⎧  
⎨1, if F eeMarkit
i,t
> 0 and NetSizet < 0 or

DealerPayi,t = F eeMarkit 0 and NetSizet 0 ,
⎩ i,t
0, otherwise
(13)
where F eeMarkit is the upfront fee for CDS contract i at day
i,t
t in the Markit data, and NetSizet is dealers’ aggregate net
position against customers at day t. A positive (negative)
F eeMarkit indicates that the CDS buyer (seller) pays an up-
i,t
front fee. A positive (negative) NetSizet indicates that deal-
ers are the net protection seller (buyer). We estimate the
following regression specification:
BidAski,t = b1 × Fi,t + b2 × Fi,t × DealerPayi,t + b3
× DealerPayi,t + γ × Xi,t + ui + vt + i,t , (14)
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X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx 15

Table 6
Placebo tests on event dates.
This table reports results from the placebo tests using the following regression specification:

BidAski,t = b1 × Fi,t + b2 × Fi,t × BBt + γ × Xi,t + ui + vt + i,t ,

where BidAski, t is the bid-ask spread for trading CDS contract i on day t, Fi, t is the upfront
funding cost for trading CDS contract i with five-year maturity on day t as defined in Eq. (2),
BBt is a dummy variable that is one if the date t is later than the event date and zero oth-
erwise, Xi, t is the set of control variables described in Section 2.2, ui is the firm fixed effect,
and vt is the day fixed effect. Columns (1) and (2) are based on regressions with fictitious
event dates for the CDS Big Bang, October 8, 2008 (sample period from April 8, 2008 to April
7, 2009) and October 8, 2009 (sample period from April 8, 2009 to April 7, 2010), respectively,
while column (3) is based on the actual event date, April 8, 2009 (sample period from April 8,
2008 to April 7, 2009). Numbers in parentheses are t-statistics based on standard errors that
are clustered by firm and time. ∗ , ∗ ∗ , and ∗ ∗ ∗ denote statistical significance at the 10%, 5%, and
1% level, respectively.

(1) (2) (3)

Placebo test 1 Placebo test 2 Baseline test

Event date 10/08/2008 10/08/2009 04/08/2009

Sample period 4/8/2008–4/7/2009 4/8/2009–4/7/2010 10/8/2008–10/7/2009
F 0.59∗ ∗ ∗ 2.51∗ ∗ ∗ 0.26∗ ∗ ∗
(2.96) (6.39) (2.84)
F × BB -0.16 0.79 1.84∗ ∗ ∗
(-0.72) (0.38) (5.68)
Control Included Included Included
Observations 54,213 66,755 57,675
R-squared 0.85 0.90 0.89
Number of firms 376 375 369

Table 7 spread. In column (2), we include the interaction term to

Asymmetric effects of the upfront costs.
test the asymmetric effects of the upfront cost. The coef-
This table reports asymmetric effects of the upfront funding
costs on CDS bid-ask spreads. The regression specification is ficient for the interaction term F × DealerPay is 2.69 and is
statistically significant (t=3.02). Given that the average of
BidAski,t = b1 × Fi,t + b2 × Fi,t × DealerPayi,t + b3
F is 0.18 bps in the Markit sample, this result suggests that
× DealerPayi,t + γ × Xi,t + ui + vt + i,t ,
the asymmetric effect has an economic magnitude of about
where Fi, t is the upfront funding cost for trading CDS contract i 0.5 bps (2.69 × 0.18).
with five-year maturity on day t defined in Eq. (2), DealerPayi, t
is a dummy variable that is one if the dealer pays upfront for
CDS contract i at day t and zero otherwise, Xi, t is the set of
4.4.2. Additional analyses
control variables described in Section 2.2, ui is the firm fixed
effect, and vt is the day fixed effect. The regression is based We conduct some additional tests that are not reported
on the North American Markit sample (April 1, 2010 to Octo- in the paper for the sake of brevity. First, in the main
ber 19, 2016). Numbers in parentheses are t-statistics based on analysis, our focus is on the interaction term F × BB. How-
standard errors that are clustered by firm and time. ∗ , ∗ ∗ , and ever, F is a product of DIS and LOIS and, thus, the interpre-
∗∗∗
denote statistical significance at the 10%, 5%, and 1% level,
respectively.
tation of its coefficient needs more careful examinations.
We identify the upfront funding cost effect using an al-
(1) (2)
ternative regression specification and examine the effects
∗∗∗
F 3.80 3.36∗ ∗ ∗ of its components separately. The results are described in
(6.15) (5.47) Online Appendix D. Second, to provide a detailed analysis
F × DealerPay 2.69∗ ∗ ∗
that coupon standardization in the CDS market improves
(3.02)
DealerPay 0.37∗ ∗ ∗ market liquidity, we examine the overall effect of the CDS
(2.63) Big Bang and Small Bang in Online Appendix E. The results
Control Included Included show that the overall effects of the CDS Big Bang and Small
Observations 333,394 333,394 Bang are liquidity enhancing. Finally, we provide additional
R-squared 0.88 0.88 robustness tests using European CDSs as a control group in
Number of firms 355 355
Online Appendix F.

where Fi, t is the upfront funding cost as defined in Eq. (2),
DealerPayi, t is a dummy variable as defined above, and Xi, t
is the set of control variables described in Section 2.2.
The regression results are reported in Table 7. In
column (1), we run a basic specification and confirm
that funding cost is an important determinant of bid-ask
5. Conclusion
The CDS Big Bang is an important step toward standard-
izing the CDS market. Coupon standardization in the CDS
market improves aggregate market liquidity but also intro-
duces capital upfront costs on CDS trading. We exploit this
historical event to study the impact of funding liquidity on

Please cite this article as: X. Wang, Y. Wu and H. Yan et al., Funding liquidity shocks in a quasi-experiment: Evidence from
the CDS Big Bang, Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2020.08.004
JID: FINEC
ARTICLE IN PRESS
16 X. Wang, Y. Wu and H. Yan et al. / Journal of Financial Economics xxx (xxxx) xxx
market liquidity. This funding shock, combined with sev-
eral other shocks that took place soon afterwards (the CDS
Small Bang, central clearing, and Deutsche Bank’s exit from
the CDS market) offers a rich setting to examine the mech-
anism relating funding liquidity to market liquidity.
Our main analyses, based on the CDS Big Bang applied
to North American CDS contracts on April 8, 2009, show
that an increase in funding requirements, i.e., an increase
in upfront costs in trading CDSs, leads to a decrease in
market liquidity. We also use variation across maturities
but within firm to identify the funding effect and find con-
sistent results. Moreover, we find that the funding effect is
stronger for CDSs on smaller or riskier reference entities.
We further conduct analyses using the implementation of
central clearing and find that central clearing alleviates
some of the funding effect through netting. In addition,
consistent with the prediction that the funding cost has
a large effect when traders are close to their constraints,
we find that the funding effect becomes stronger after
the exit of Deutsche Bank. Finally, we conduct a series
of placebo tests to provide support that our main results
are indeed attributed to the implementation of the CDS
Big Bang.
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