| By: |
Ioana Alexopoulou (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.);
Magnus Andersson (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.);
Oana Maria Georgescu (KfW Bankengruppe, Palmengartenstraße 5-9, D-60325 Frankfurt am Main, Germany.) |
| Abstract: |
Applied to the European markets, this paper analyzes the price of credit risk
on the Credit Default Swap (CDS) and corporate bond markets by comparing the
sensitivity of the credit spreads on each market to systematic, idiosyncratic
risk factors and liquidity. Our analysis confirms the existence of a long-run
relationship between the two markets, and the tendency for CDS markets to lead
corporate bond markets in terms of price discovery. We find that the outbreak
of the financial turmoil in the summer of 2007 induced a substantial increase
in risk aversion and a shift in the pricing of credit risk, with CDS markets
becoming more sensitive to systematic risk while cash bond markets priced in
more information about liquidity and idiosyncratic risk. Moreover, the
financial turbulence also brought about a systematic disconnection between the
two markets caused by the significant change in the lead-lag relationship,
with CDS markets always leading the cash bond markets. JEL Classification:
G12, G14, G15. |
| Keywords: |
Credit Default Swap Spreads, Corporate Bond Spreads, Liquidity. |
| Date: |
2009–08 |
| URL: |
http://d.repec.org/n?u=RePEc:ecb:ecbwps:20091085&r=mst |