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The Determinants of Market Frictions in the Corporate Market

Egon Zakrajsek (), Andrew Levin () and Roberto Perli

No 379, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: We construct an empirical measure of market frictions in the corporate market based on the difference between the corporate bond spread and the credit default swap spread for a large number of firms in a new, large dataset that we construct. Under fairly standard assumptions, the two spreads should be equal; if they diverge, we argue that significant market frictions are present that prevent investors' from arbitraging away what in effect are opportunities to earn a risk-free profit. We find that, after accounting for several technical factors, the measure changes over time in coincidence with well-known events that affected the corporate market in the past several years. In addition, several macroeconomic and financial variables appear to account for a substantial part of the changes in corporate market frictions over time. We also conduct an event-study type of analysis to relate our measure to monetary-policy-related events, such as changes in the target federal funds rate, speeches by Federal Reserve officials, and data releases that are closely followed by FOMC observers, such as the monthly employment reports and CPI releases

Keywords: Credit Default Swaps; Corporate Bonds; Market Frictions (search for similar items in EconPapers)
JEL-codes: G00 G10 G14 (search for similar items in EconPapers)
Date: 2005-11-11
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