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Collateral affects return risk: evidence from the euro bond market

Stig Helberg and Snorre Lindset ()
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Snorre Lindset: Norwegian University of Science and Technology

Financial Markets and Portfolio Management, 2020, vol. 34, issue 1, No 4, 99-128

Abstract: Abstract Covered bonds and senior bonds are prominent securities in the euro bond market. Senior bonds are unsecured, while covered bonds are secured—backed by collateral. Our results show that the presence of collateral reduces the total risk in individual bonds by more than 70%. Compared to diversified portfolios of senior bonds, diversified portfolios of covered bonds have a significantly lower level of systematic risk. However, the fraction of systematic risk to total risk is higher for covered bonds. By decomposing the variance of bond returns, we find that around 33% of the risk in senior bonds is systematic, versus 53% in covered bonds. Both types of bonds contain instrument-specific risk.

Keywords: Covered bonds; Senior bonds; Systematic risk; Unsystematic risk; Instrument-specific risk (search for similar items in EconPapers)
JEL-codes: G19 G21 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s11408-019-00343-2

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