An empirical study on the decoupling movements between corporate bond and CDS spreads
AbstractApplied to the European markets, this paper analyzes the price of credit risk on the Credit Default Swap (CDS) and corporate bond markets by comparing the sensitivity of the credit spreads on each market to systematic, idiosyncratic risk factors and liquidity. Our analysis confirms the existence of a long-run relationship between the two markets, and the tendency for CDS markets to lead corporate bond markets in terms of price discovery. We find that the outbreak of the financial turmoil in the summer of 2007 induced a substantial increase in risk aversion and a shift in the pricing of credit risk, with CDS markets becoming more sensitive to systematic risk while cash bond markets priced in more information about liquidity and idiosyncratic risk. Moreover, the financial turbulence also brought about a systematic disconnection between the two markets caused by the significant change in the lead-lag relationship, with CDS markets always leading the cash bond markets. JEL Classification: G12, G14, G15
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Bibliographic InfoPaper provided by European Central Bank in its series Working Paper Series with number 1085.
Date of creation: Aug 2009
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Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-09-11 (All new papers)
- NEP-BEC-2009-09-11 (Business Economics)
- NEP-EEC-2009-09-11 (European Economics)
- NEP-MST-2009-09-11 (Market Microstructure)
- NEP-RMG-2009-09-11 (Risk Management)
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- Luciana Barbosa & Sónia Costa, 2010. "Determinants of sovereign bond yield spreads in the euro area in," Working Papers w201022, Banco de Portugal, Economics and Research Department.
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