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An empirical comparison of credit spreads between the bond market and the credit default swap market

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  • Haibin Zhu

Abstract

This paper compares the pricing of credit risk in the bond market and the fast-growing credit default swap (CDS) market. The empirical findings confirm the theoretical prediction that bond spreads and CDS spreads move together in the long run. Nevertheless, in the short run this relationship does not always hold. The deviation is largely due to different responses of the two markets to changes in credit conditions. By looking into the dynamic linkages between the two spreads, I find that the CDS market often moves ahead of the bond market in price adjustment, particularly for US entities. Liquidity also matters for their role in price discovery. Surprisingly, the terms of CDS contracts and the short-sale restriction in the cash market only have a very small impact.

Suggested Citation

  • Haibin Zhu, 2004. "An empirical comparison of credit spreads between the bond market and the credit default swap market," BIS Working Papers 160, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:160
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    References listed on IDEAS

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    1. Patrick Houweling & Ton Vorst, 2001. "An Empirical Comparison of Default Swap Pricing Models," Finance 0112003, University Library of Munich, Germany.
    2. Robert A. Jarrow & Stuart M. Turnbull, 2008. "Pricing Derivatives on Financial Securities Subject to Credit Risk," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409, World Scientific Publishing Co. Pte. Ltd..
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