Are European Corporate Bond and Default Swap Markets Segmented?

Didier Cossin () and Hongze Lu ()
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Didier Cossin: IMD International
Hongze Lu: IMD International, HEC, University of Lausanne

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: Market prices of corporate bond spreads and of credit default swap (CDS) rates do not match each other. In this paper, we argue that the liquidity premium, the cheapest-to-deliver (CTD) option and actual market segmentation explain the pricing differences. Using the European transaction data from Reuters and Bloomberg, we estimate a liquidity premium that is time-varying and firm-specific. We show that when time-dependent liquidity premiums are considered, corporate bond spreads and CDS rates behave in a much closer way than previous studies have shown. We also find that high equity volatility drives pricing differences that can be explained by the CTD option.

Keywords: credit default swap; corporate bond yields; liquidity premium; cheapest-to-deliver options; debt-CDS arbitrage (search for similar items in EconPapers)
JEL-codes: C13 G12 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec
Date: 2005-03
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Persistent link: http://EconPapers.repec.org/RePEc:fam:rpseri:rp133

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