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An empirical study on the decoupling movements between corporate bond and CDS spreads

Author

Listed:
  • Andersson, Magnus
  • Alexopoulou, Ioana
  • Georgescu, Oana-Maria

Abstract

Applied 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

Suggested Citation

  • Andersson, Magnus & Alexopoulou, Ioana & Georgescu, Oana-Maria, 2009. "An empirical study on the decoupling movements between corporate bond and CDS spreads," Working Paper Series 1085, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20091085
    Note: 568808
    as

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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1085.pdf
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    Citations

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    Cited by:

    1. Óscar Arce & Sergio Mayordomo & Juan Ignacio Peña, 2012. "Credit-valuation in the sovereing CDS and bonds markets: Evidence from the euro area crisis," CNMV Working Papers CNMV Working Papers no. 5, CNMV- Spanish Securities Markets Commission - Research and Statistics Department.
    2. Kim, Gi H. & Li, Haitao & Zhang, Weina, 2016. "CDS-bond basis and bond return predictability," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 307-337.
    3. Fischer, Henning & Stolper, Oscar, 2019. "The nonlinear dynamics of corporate bond spreads: Regime-dependent effects of their determinants," Discussion Papers 08/2019, Deutsche Bundesbank.
    4. Corò, Filippo & Dufour, Alfonso & Varotto, Simone, 2013. "Credit and liquidity components of corporate CDS spreads," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5511-5525.
    5. Arce, Oscar & Mayordomo, Sergio & Peña, Juan Ignacio, 2013. "Credit-risk valuation in the sovereign CDS and bonds markets: Evidence from the euro area crisis," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 124-145.
    6. Bhanot, Karan & Burns, Natasha & Hunter, Delroy & Williams, Michael, 2014. "News spillovers from the Greek debt crisis: Impact on the Eurozone financial sector," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 51-63.
    7. repec:zbw:rwirep:0243 is not listed on IDEAS
    8. Jorge M. Andraz & Cristina M. Viegas & Nélia M. Norte, 2016. "On the relationship between sovereign bonds and credit default swaps in Portugal," International Journal of Economic Sciences, International Institute of Social and Economic Sciences, vol. 5(1), pages 18-36, March.
    9. Ansgar Belke & Christian Gokus, 2011. "Volatility Patterns of CDS, Bond and Stock Markets before and during the Financial Crisis: Evidence from Major Financial Institutions," Discussion Papers of DIW Berlin 1107, DIW Berlin, German Institute for Economic Research.
    10. Zuccardi Huertas Igor Esteban, 2015. "Sovereign Spreads in the Eurozone: Is Market Discipline Working?," Working Papers 2015-20, Banco de México.
    11. Peter Claeys & Borek Vašícek, 2012. "“Measuring Sovereign Bond Spillover in Europe and the Impact of Rating News”," IREA Working Papers 201219, University of Barcelona, Research Institute of Applied Economics, revised Nov 2012.
    12. Óscar Arce & Fco. Javier González Pueyo & Lucio Sanjuán, 2010. "The Credit Default Swaps market: areas of vulnerability and regulatory responses," CNMV Working Papers CNMV Working Papers no. 4, CNMV- Spanish Securities Markets Commission - Research and Statistics Department.
    13. Karan Bhanot & Natasha Burns & Delroy Hunter & Michael Williams, 2013. "News Spillovers from the Greek Debt Crisis: Impact on the Eurozone Financial Sector," Working Papers 0176fin, College of Business, University of Texas at San Antonio.
    14. Marcia Millon Cornette & Hamid Mehran & Kevin Pan & Minh Phan & Chenyang Wei, 2014. "CDS and equity market reactions to stock issuances in the U.S. financial industry: evidence from the 2002-13 period," Staff Reports 697, Federal Reserve Bank of New York.
    15. Xiaoqing Fu & Matthew C. Li & Philip Molyneux, 2021. "Credit default swap spreads: market conditions, firm performance, and the impact of the 2007–2009 financial crisis," Empirical Economics, Springer, vol. 60(5), pages 2203-2225, May.
    16. Ansgar Belke & Christian Gokus, 2011. "Volatility Patterns of CDS, Bond and Stock Markets Before and During the Financial Crisis – Evidence from Major Financial Institutions," Ruhr Economic Papers 0243, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
    17. Luciana Barbosa & Sónia Costa, 2010. "Determinants of the sovereign bond yield spreads in the Euro Area in the context of the economic and financial crisis," Working Papers w201022, Banco de Portugal, Economics and Research Department.
    18. Marc Peters & Hugues Pirotte, 2014. "Unveiling Sovereign Effects in European Banks CDS Spreads Variations," Working Papers CEB 14-018, ULB -- Universite Libre de Bruxelles.
    19. Téllez Valle, Cecilia & Martín García, Margarita & Ramón-Jerónimo, María A. & Martín Marín, José Luis, 2020. "Sovereign bond spreads and CDS premia in the Eurozone: A causality analysis || Diferenciales de bonos soberanos y primas de CDS en la zona euro: un análisis de causalidad," Revista de Métodos Cuantitativos para la Economía y la Empresa = Journal of Quantitative Methods for Economics and Business Administration, Universidad Pablo de Olavide, Department of Quantitative Methods for Economics and Business Administration, vol. 30(1), pages 58-78, December.

    More about this item

    Keywords

    corporate bond spreads; Credit Default Swap Spreads; liquidity;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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