An empirical study on the decoupling movements between corporate bond and CDS spreads

Ioana Alexopoulou (), Magnus Andersson () and Oana Maria Georgescu ()
Additional contact information
Ioana Alexopoulou: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany., http://www.ecb.europa.eu/home/html/index.en.html
Magnus Andersson: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany., http://www.ecb.europa.eu/home/html/index.en.html
Oana Maria Georgescu: KfW Bankengruppe, Palmengartenstraße 5-9, 60325 Frankfurt am Main, Germany., http://www.kfw.de/

No 1085, Working Paper Series from European Central Bank

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. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-eec, nep-mst and nep-rmg
Date: 2009-08

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