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Household Sentiment, Market Liquidity, and Credit Default Swap Spreads

We show that household sentiment affects the cross-section and time-series of credit default swap (CDS) spreads. We employ internet search volume data to proxy for an exogenous shock to the pessimistic sentiment of households about credit risk outside the CDS market. Consistent with the conjecture of significant noise trading existing in the CDS market, we find our proxy of household sentiment to be a significant driver of CDS spreads. Our results are in line with theories that emphasize the role noise trading plays in providing market liquidity with higher levels of sentiment being associated with lower average CDS spreads.