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Are European Corporate Bond and Default Swap Markets Segmented?

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Author Info

  • Didier Cossin

    ()
    (IMD International)

  • Hongze Lu

    ()
    (IMD International, HEC, University of Lausanne)

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    Abstract

    Market prices of corporate bond spreads and of credit default swap (CDS) rates do not match each other. In this paper, we argue that the liquidity premium, the cheapest-to-deliver (CTD) option and actual market segmentation explain the pricing differences. Using the European transaction data from Reuters and Bloomberg, we estimate a liquidity premium that is time-varying and firm-specific. We show that when time-dependent liquidity premiums are considered, corporate bond spreads and CDS rates behave in a much closer way than previous studies have shown. We also find that high equity volatility drives pricing differences that can be explained by the CTD option.

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    Bibliographic Info

    Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp133.

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    Date of creation: Mar 2005
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    Handle: RePEc:fam:rpseri:rp133

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    Related research

    Keywords: credit default swap; corporate bond yields; liquidity premium; cheapest-to-deliver options; debt-CDS arbitrage;

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    Cited by:
    1. Jan De Wit, 2006. "Exploring the CDS-Bond Basis," Working Paper Research 104, National Bank of Belgium.

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