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Spurious Cross-Sectional Dependence in Credit Spread Changes

Marcin Jaskowski and Michael McAleer

No EI 208-34, Econometric Institute Research Papers from Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute

Abstract: In order to understand the lingering credit risk puzzle and the apparent segmentation of the stock market from credit markets, we need to be able to assess the strength of the cross-sectional dependence in credit spreads. This turns out to be a non-trivial task due to the extreme data sparsity that is typical for any panel of credit spreads that is extracted from corporate bond transactions. The problem of data sparsity has led to some erroneous conclusions in the literature, including inferences that have been drawn from spurious cross-sectional dependence in credit spread changes. Understanding the pitfalls leads to a new and improved estimator of the latent factor in credit spread changes and its characteristics.

Keywords: Credit spread puzzle; Market segmentation; Latent factors; Spurious cross-sectional dependence (search for similar items in EconPapers)
JEL-codes: E43 G12 G13 G17 (search for similar items in EconPapers)
Pages: 30
Date: 2018-08-01
New Economics Papers: this item is included in nep-fmk, nep-mac and nep-ore
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Related works:
Journal Article: Spurious cross-sectional dependence in credit spread changes (2021) Downloads
Working Paper: Spurious Cross-Sectional Dependence in Credit Spread Changes (2018) Downloads
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