Are European Corporate Bond and Default Swap Markets Segmented?
AbstractMarket 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 InfoPaper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp133.
Date of creation: Mar 2005
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credit default swap; corporate bond yields; liquidity premium; cheapest-to-deliver options; debt-CDS arbitrage;
Find related papers by JEL classification:
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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- Jan De Wit, 2006. "Exploring the CDS-Bond Basis," Working Paper Research 104, National Bank of Belgium.
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