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The Determinants of Market Frictions in the Corporate Market

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  • Egon Zakrajsek
  • Andrew Levin
  • Roberto Perli

Abstract

We construct an empirical measure of market frictions in the corporate market based on the difference between the corporate bond spread and the credit default swap spread for a large number of firms in a new, large dataset that we construct. Under fairly standard assumptions, the two spreads should be equal; if they diverge, we argue that significant market frictions are present that prevent investors' from arbitraging away what in effect are opportunities to earn a risk-free profit. We find that, after accounting for several technical factors, the measure changes over time in coincidence with well-known events that affected the corporate market in the past several years. In addition, several macroeconomic and financial variables appear to account for a substantial part of the changes in corporate market frictions over time. We also conduct an event-study type of analysis to relate our measure to monetary-policy-related events, such as changes in the target federal funds rate, speeches by Federal Reserve officials, and data releases that are closely followed by FOMC observers, such as the monthly employment reports and CPI releases

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 379.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:379

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Related research

Keywords: Credit Default Swaps; Corporate Bonds; Market Frictions;

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Cited by:
  1. Sergio Mayordomo & Juan Ignacio Peña & Juan Romo, 2009. "Are There Arbitrage Opportunities in Credit Derivatives Markets? A New Test and an Application to the Case of CDS and ASPs," Business Economics Working Papers wb096303, Universidad Carlos III, Departamento de Economía de la Empresa.
  2. Nicholas Apergis & Emmanuel Mamatzakis & Christos Staikouras, 2011. "Testing for Regime Changes in Greek Sovereign Debt Crisis," International Advances in Economic Research, Springer, vol. 17(3), pages 258-273, August.

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