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The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices

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  • Ingo Fender
  • Martin Scheicher

Abstract

This article investigates the pricing of subprime mortgage risk using data for the ABX.HE indices, which have become a key barometer of market conditions during the recent financial crisis. After a discussion of ABX index mechanics and observed pricing patterns, we use regression analysis to establish the relationship between observed index returns and macroeconomic news as well as market-based proxies of various pricing factors. The results imply that declining risk appetite and heightened concerns about market illiquidity-likely due in part to significant short positioning-have provided a sizeable contribution to the observed collapse in ABX prices. In particular, while fundamental factors, such as housing market activity, have continued to exert an important influence on the subordinated indices, those backed by senior exposures have tended to react more to the general deterioration of the financial market environment. This provides further support for the inappropriateness of pricing models that do not account sufficiently for factors such as risk appetite and liquidity risk, particularly in periods of stress. In addition, as related risk premia can be captured by unconstrained investors, these findings lend support to government measures aimed at taking troubled assets off banks' balance sheets (e.g. the Troubled Asset Relief Program).

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File URL: http://www.tandfonline.com/doi/abs/10.1080/09603100903282689
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 19 (2009)
Issue (Month): 24 ()
Pages: 1925-1945

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Handle: RePEc:taf:apfiec:v:19:y:2009:i:24:p:1925-1945

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  1. Jeffery D Amato & Eli M Remolona, 2003. "The credit spread puzzle," BIS Quarterly Review, Bank for International Settlements, December.
  2. John Y. Campbell & Glen B. Taksler, 2003. "Equity Volatility and Corporate Bond Yields," Journal of Finance, American Finance Association, vol. 58(6), pages 2321-2350, December.
  3. Coudert, Virginie & Gex, Mathieu, 2008. "Does risk aversion drive financial crises? Testing the predictive power of empirical indicators," Journal of Empirical Finance, Elsevier, vol. 15(2), pages 167-184, March.
  4. Benjamin Yibin Zhang & Hao Zhou & Haibin Zhu, 2009. "Explaining Credit Default Swap Spreads with the Equity Volatility and Jump Risks of Individual Firms," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5099-5131, December.
  5. Paul S. Mills & John Kiff, 2007. "Money for Nothing and Checks for Free," IMF Working Papers 07/188, International Monetary Fund.
  6. Ingo Fender & John Kiff, 2004. "CDO rating methodology: Some thoughts on model risk and its implications," BIS Working Papers 163, Bank for International Settlements.
  7. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
  8. Cantor, Richard, 2004. "An introduction to recent research on credit ratings," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2565-2573, November.
  9. Allen Frankel, 2006. "Prime or not so prime? An exploration of US housing finance in the new century," BIS Quarterly Review, Bank for International Settlements, March.
  10. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
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Cited by:
  1. Gary Gorton & Andrew Metrick, 2009. "Securitized Banking and the Run on Repo," Yale School of Management Working Papers amz2358, Yale School of Management, revised 01 Sep 2009.
  2. Thomas Flavin & Gerald P. Dwyer & Mardi Dungey, 2011. "Systematic and Liquidity Risk in Subprime-Mortgage Backed SecuritiesM," Economics, Finance and Accounting Department Working Paper Series n219-11, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  3. Ingo Fender & Bernd Hayo & Matthias Neuenkirch, 2011. "Daily CDS pricing in emerging markets before and during the global financial crisis," MAGKS Papers on Economics 201139, Philipps-Universit├Ąt Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  4. Fender, Ingo & Hayo, Bernd & Neuenkirch, Matthias, 2012. "Daily pricing of emerging market sovereign CDS before and during the global financial crisis," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2786-2794.

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