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

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  • Alexopoulou, Ioana
  • Andersson, Magnus
  • Georgescu, Oana Maria
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    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

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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 1085.

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    Date of creation: Aug 2009
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    Handle: RePEc:ecb:ecbwps:20091085

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    Keywords: corporate bond spreads; Credit Default Swap Spreads; liquidity;

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    Cited by:
    1. : Haitao Li & Weina Zhang & Gi H. Kim, 2011. "The CDS-Bond Basis Arbitrage and the Cross Section of Corporate Bond Returns," Working Papers, Warwick Business School, Finance Group wpn11-04, Warwick Business School, Finance Group.
    2. 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, Elsevier, vol. 35(C), pages 124-145.
    3. 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.
    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. 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.
    6. : Haitao Li & Gi H. Kim & Weina Zhang, 2010. "The CDS-Bond Basis and the Cross Section of Corporate Bond Returns," Working Papers, Warwick Business School, Finance Group wpn10-03, Warwick Business School, Finance Group.

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