A joint non-parametric approach to the decomposition of bond yields and CDS spreads: application of Eurozone market data
AbstractIn this paper we develop a joint non-parametric approach to the problem of the decomposition of bond yields and CDS spreads. The proposed approach is essentially an infinite-dimensional modification of the Heath-Jarrow-Morton framework and is general enough to capture even very non-trivial shapes of the yield and hazard-rate curves. The approach allows us to jointly estimate entire term structures of yields, hazard rates, and liquidity premiums, no matter what shapes they take. We apply the developed methodology to data on major Eurozone sovereign borrowers and consider the most recent period of the Eurozone debt crisis. Our data set includes instruments with maturities from 6 months to 30 years. As a result, we found several interesting interaction effects between those components in terms of term structure. Treating the bond-CDS basis as a measure of the cross-market liquidity spread, we find that cross-market liquidity evolves in a rather non-trivial and pronounced manner. As the credit quality of the reference entity deteriorates, the liquidity of the CDS market dries up, starting from longer terms.
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Bibliographic InfoPaper provided by National Research University Higher School of Economics in its series HSE Working papers with number WP BRP 13/FE/2013.
Length: 20 pages
Date of creation: 2013
Date of revision:
Publication status: Published in WP BRP Series: Financial Economics / FE, March 2013, pages 1-20
term structure; interest rates; credit risk; default intensity; liquidity premium; bond; credit default swap; risk premium.;
Find related papers by JEL classification:
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-12-06 (All new papers)
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