An empirical comparison of credit spreads between the bond market and the credit default swap market
AbstractThis paper compares the pricing of credit risk in the bond market and the fast-growing credit default swap (CDS) market. The empirical findings confirm the theoretical prediction that bond spreads and CDS spreads move together in the long run. Nevertheless, in the short run this relationship does not always hold. The deviation is largely due to different responses of the two markets to changes in credit conditions. By looking into the dynamic linkages between the two spreads, I find that the CDS market often moves ahead of the bond market in price adjustment, particularly for US entities. Liquidity also matters for their role in price discovery. Surprisingly, the terms of CDS contracts and the short-sale restriction in the cash market only have a very small impact.
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Bibliographic InfoPaper provided by Bank for International Settlements in its series BIS Working Papers with number 160.
Length: 37 pages
Date of creation: Aug 2004
Date of revision:
credit spreads comparison; bond market; credit default swap market;
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