The CDS-Bond Basis Arbitrage and the Cross Section of Corporate Bond Returns PDF Download

Author: Gi H. Kim
Publisher:
ISBN:
Category :
Languages : en
Pages : 42

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Book Description
We provide a comprehensive empirical analysis on the implication of CDS-Bond basis arbitrage for the pricing of corporate bonds. Basis arbitrageurs introduce new risks such as funding liquidity and counterparty risk into the corporate bond market, which was dominated by passive investors before the existence of CDS. We show that a basis factor, constructed as the return differential between LOW and HIGH quintile basis portfolios, is a superior empirical proxy that captures the new risks. In the cross section of investment grade bond returns, the basis factor carries an annual risk premium of about 3% in normal periods.

Author: Jennie Bai
Publisher:
ISBN:
Category :
Languages : en
Pages : 41

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Book Description
We investigate the cross-sectional variation in the CDS-bond basis, which measures the difference between credit default swap (CDS) spread and cash-bond implied credit spread. We test several explanations for the violation of the arbitrage relation between cash bond and CDS contract, which states that the basis should be zero in normal conditions. The evidence is consistent with `limits to arbitrage' theories in that deviations are larger for bonds with higher frictions as measured by trading liquidity, funding cost, counterparty risk, and collateral quality. Surprisingly however, we find that the basis is more negative when the bond lending fee is higher, suggesting that arbitrageurs are unwilling to engage in a negative basis trade when short interest on the bond is high.

Author: Gi H. Kim
Publisher:
ISBN:
Category :
Languages : en
Pages : 69

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Book Description
We examine the predictive power of the CDS-bond basis for future corporate bond returns. We find that residual basis, the part of the CDS-bond basis that cannot be explained by a wide range of market frictions such as counterparty risk, funding risk, and liquidity risk, strongly negatively predicts excess returns. Controlling for systematic risk factors, including credit risk and liquidity risk, we find that a bond portfolio formed on the residual basis generates a significant abnormal bond return of 1.79% at the 20-day horizon. The abnormal returns due to the residual basis reflect mispricing rather than missing systematic risk factors. These results are robust to different horizons and sample periods and to the various characteristics of bonds. Overall, our results imply a beneficial role of CDS in the bond market as the existence of mispricing between CDS and bonds results in a subsequent price convergence in bonds.

Author: Söhnke M. Bartram
Publisher:
ISBN:
Category : Bonds
Languages : en
Pages : 0

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Book Description
A corporate bond’s book value divided by its market price strongly predicts its return from actual transactions occurring at least eight days after observing the signal. Bonds with the 20% highest “bond book-to-market ratios” outperform their lowest quintile counterparts by 3%-4% per year, other things equal. The finding controls for numerous attributes tied to liquidity, default, microstructure, and priced asset risk, including yield, credit spread, structural model equity hedges, bond rating, and maturity. If an efficient markets story explained the 3%-4% spread, we would not observe (as we do) rapid decay in the ratio’s predictive efficacy with implementation delays beyond one month, efficacy across the bond-type spectrum, and an inability of microstructure, factor risk, and bond attributes to account for the anomaly.

Author: Jennie Bai
Publisher:
ISBN:
Category :
Languages : en
Pages : 75

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Book Description
We investigate the cross-sectional determinants of corporate bond returns and find that downside risk is the strongest predictor of future bond returns. We also introduce common risk factors based on the prevalent risk characteristics of corporate bonds -- downside risk, credit risk, and liquidity risk -- and find that these novel bond factors have economically and statistically significant risk premia that cannot be explained by long-established stock and bond market factors. We show that the newly proposed risk factors outperform all other models considered in the literature in explaining the returns of the industry- and size/maturity-sorted portfolios of corporate bonds.

Author: Kee H. Chung
Publisher:
ISBN:
Category :
Languages : en
Pages : 45

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Book Description
This paper examines the pricing of volatility risk and idiosyncratic volatility in the cross-section of corporate bond returns for the period of 1994-2016. Results show that bonds with high volatility betas have low expected returns and this negative relation appears in all segments of corporate bonds. Further, bonds with high idiosyncratic bond (stock) volatility have high (low) expected returns, and this relation strengthens as ratings decrease. Conventional risk factors and bond/issuer characteristics cannot account for these cross-sectional relations. There is evidence that the effect of idiosyncratic stock volatility on expected bond returns works through the channel of contemporaneous stock returns.

Author: William R. Gebhardt
Publisher:
ISBN:
Category :
Languages : en
Pages : 43

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Book Description
This paper finds that default betas are significantly related to the cross-section of average bond returns even after controlling for characteristics such as duration, ratings, and yield-to-maturity. Among characteristics, only yield-to-maturity is significantly related to average bond returns after controlling for default and term betas. The default and term factors are able to price the returns of beta-sorted portfolios better than they do the returns of yield-sorted portfolios. The magnitude of the ex ante Sharpe ratio generated by yield-sorted portfolios suggests non-risk based explanations. Overall, given the elusive nature of systematic risk in empirical asset pricing, the central finding of our paper is that systematic risk matters for corporate bonds.

Author: Marti Subrahmanyam
Publisher: Now Publishers
ISBN: 9781601989000
Category : Business & Economics
Languages : en
Pages : 150

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Book Description
Credit Default Swaps: A Survey is the most comprehensive review of all major research domains involving credit default swaps (CDS). CDS have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly since the credit crisis of 2007-2009. The authors review the extant literature on CDS that has accumulated over the past two decades and divide the survey into seven topics after providing a broad overview in the introduction. The second section traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third section discusses the pricing of CDS, from the perspective of no-arbitrage principles, structural, and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth section discusses how the development of the CDS market has affected the characteristics of the bond and equity markets, with an emphasis on market efficiency, price discovery, information flow, and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market. The fifth section examines the effect of CDS trading on firms' credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and corporate governance. The sixth section analyzes how CDS impact the economic incentives of financial intermediaries. The seventh section reviews the growing literature on sovereign CDS and highlights the major differences between the sovereign and corporate CDS markets. The eighth section discusses CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis. The authors close with our suggestions for promising future research directions on CDS contracts and markets.

Author: Himanshu Verma
Publisher:
ISBN:
Category :
Languages : en
Pages : 19

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Book Description
We examine momentum and reversal anomalies in corporate bond returns at the firm-level employing a novel dataset, SoKat Credit, comprising bonds of 323 of the largest and liquid companies over the period from 2002 to 2020. Our study documents significant short-term reversal in the cross-sectional of corporate bond returns concentrated at the one week interval with annualized returns on the zero investment long-short portfolio of 9.9%. We also document company-level momentum spillover effect into corporate bond returns when sorting on past equity returns, that is, our “bond-stock” strategy, which delivers annualized return of 5.0% is statistically significant and robust baring the usual suspects of caveats.

Author: Stephen E. Christophe
Publisher:
ISBN:
Category :
Languages : en
Pages :

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Book Description
This paper examines the relationship between short selling in the equity market and corporate bond returns. We show that both shorting activity and size of short trades are inversely correlated with contemporaneous bond returns. In addition, firms with heavily shorted shares or large short trade size experience significantly negative future bond returns. Further tests indicate that the relation between short trade size and subsequent bond returns is consistent with stealth trading of short sellers. The impact of both shorting activity and short trade size on bond returns is robust to various controls for risk, liquidity, and other pricing factors. In examining the sources of information in short selling, we find that firms associated with heavy short selling or large short trade size are likely to subsequently experience negative earnings surprises, higher credit risk, and reduced dividends. The overall results support the proposition that short trades in the equity market exert important valuation consequences in the corporate bond market.