An empirical comparison of credit spreads between the bond market and the credit default swap market
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.
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| Length: | 37 pages |
| Date of creation: | Aug 2004 |
| Handle: | RePEc:bis:biswps:160 |
| Contact details of provider: | Postal: Centralbahnplatz 2, CH - 4002 Basel Phone: (41) 61 - 280 80 80 Fax: (41) 61 - 280 91 00 Web page: http://www.bis.org/ Email: More information through EDIRC
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References listed on IDEAS
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- 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..
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
- Patrick Houweling & Ton Vorst, 2001. "An Empirical Comparison of Default Swap Pricing Models," Finance 0112003, EconWPA.
- Patrick Houweling & Ton Vorst, 2002. "An Empirical Comparison of Default Swap Pricing Models," Tinbergen Institute Discussion Papers 02-004/2, Tinbergen Institute.
- Houweling, P. & Vorst, A.C.F., 2002. "An Empirical Comparison of Default Swap Pricing Models," Econometric Institute Research Papers ERS-2002-23-F&A, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
- Houweling, P. & Vorst, A.C.F., 2002. "An Empirical Comparison of Default Swap Pricing Models," ERIM Report Series Research in Management ERS-2002-23-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
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