Two Essays on Corporate Bonds Credit Spreads PDF Download

Author: Siamak (Hossein) Javadi Asl
Publisher:
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Languages : en
Pages : 173

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Abstract Essay1: This paper examines joint default risk and its bond pricing implications. Constructing a measure of default correlation from CDS data, we show that default correlation is priced in bond market. Default correlation is more pronounced during periods of financial distress and for speculative issues. Also, consistent with theory, we establish a link between default correlation, secondary bond market liquidity, and the overall economic condition. Deterioration in secondary bond market liquidity raises the default boundary across the board and triggers default correlation. Our results provide a direct evidence for an intricate interaction between default risk premium and liquidity risk premium and have significant risk management and policy implications.

Author: Elmira Shekari Namin
Publisher:
ISBN:
Category : Corporate bonds
Languages : en
Pages : 274

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Author: Mahsa Somayeh Kaviani
Publisher:
ISBN:
Category :
Languages : en
Pages : 167

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In the first of three essays, we study the relationship between corporate debt structures and the strength of creditor rights. Firms use a more concentrated debt-type structure as a reaction mechanism to stronger creditor rights. We show that managers form more concentrated debt structures in response to stronger creditor rights in order to first, reduce bankruptcy costs and second, to provide more monitoring incentives for creditors. Across 46 countries, we document that firms have more concentrated debt-type structures in countries with stronger creditor rights. Based on an examination of the cross-sectional heterogeneity of firms to different creditor rights regimes, we confirm our two proposed mechanisms. This study extends the literature of debt structure to an international setting and is the first to document the effect of cross-country legal and institutional determinants on the choice of debt structures. In the second essay, we investigate how uncertainty about economic policies influence corporate credit spreads. We find a large and positive association between corporate credit spreads and a news-based index of policy uncertainty. We document that a one standard deviation increase in policy uncertainty results in 25 basis points increase in the credit spreads of corporate bonds controlling for bond, firm and macro-economic variables. We find that the influence of policy uncertainty on corporate credit spreads differs across firms and is more pronounced for firms with higher investment irreversibility and dependence on government spending. We also document a larger impact of policy uncertainty during economic recessions. Our results show that not only firm-level default probabilities, but also bond-CDS bases increase in response to elevated policy uncertainty. The third and final essay empirically measures the financial and economic costs (benefits) to firm value associated with deteriorations or improvements in the firm’s credit quality. We document that firms incur economically large and statistically significant costs to their values following credit-rating deteriorations. Consistent with an asymmetric effect, we find significant but smaller firm-value benefits associated with credit-rating upgrades. The financial costs to a firm’s market value associated with each notch downgrade to the investment and speculative grade categories are 7.1% and 14.8%, respectively, and these costs are generally larger than the economic costs to the firm value from credit rating downgrades. Using a continuous KMV distance to default model, we conclude that deteriorations (improvements) in a model-generated credit rating quality can also adversely (positively) affect firm value. Our findings have implications for corporate financing and leverage decisions, and for the unresolved underleverage puzzle (Graham, 2001).

Author: Wassim Dbouk
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Category :
Languages : en
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Author: Arne Wilkes
Publisher: Peter Lang Gmbh, Internationaler Verlag Der Wissenschaften
ISBN: 9783631606049
Category : Bond market
Languages : en
Pages : 0

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Credit spreads express how markets evaluate the riskiness of corporate bonds compared to risk-free investments. Since credit spreads have been highly volatile especially during the last decade it is important for academics and practitioners alike to understand the dynamic interdependencies between credit spreads and their determinants. Based on a sample of European corporate bonds and different macroeconomic variables the author analyzes the determinants of credit spreads during the period of 1999 to 2009. With a macro-finance term structure model he shows that the European corporate bond market is largely integrated with some remaining segmentation. Furthermore, panel regressions yield that declining liquidity leads to a significant widening of credit spreads especially during the recent financial crisis. Finally, he demonstrates based on a cointegration analysis that a long-term relationship exists between credit spreads and their determinants and that credit spreads were significantly overpriced after the collapse of Lehman Brothers but have almost returned to equilibrium towards the end of 2009.

Author: Sebastian Bethke
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Category :
Languages : en
Pages :

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Author: Jack C. Bao
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Category :
Languages : en
Pages : 151

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(cont.) In the third chapter (co-authored with Jun Pan and Jiang Wang), we examine the liquidity of corporate bonds and its asset-pricing implications. Our measure of illiquidity is based on the magnitude of transitory price movements. Using transaction-level data, we find the illiquidity in corporate bonds to be significant, substantially greater than what can be explained by the bid-ask bounce, and closely related to bond characteristics. We also find a strong commonality in the time variation of bond illiquidity, which rises sharply during market crises. Monthly changes in aggregate bond illiquidity are strongly related to changes in the CBOE VIX index. Finally, we find a relation between our measure of bond illiquidity and the cross-sectional variation in bond yield spreads.

Author: Zhan Shi
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Category :
Languages : en
Pages :

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This dissertation contains five essays on the implications of risks and ambiguity for asset pricing puzzles, especially in the fixed income market. The first essay studies the effects of time-varying Knightian uncertainty (ambiguity) on equilibrium asset prices; the second and third essays focus on the term premia in the nominal and real Treasury bond markets; The last two examine the performance of structural models of credit risk in explaining the levels and changes of corporate yield spreads.In the first essay, I consider a continuous-time Lucas exchange economy in which an ambiguity-averse agent applies a discount rate that is adjusted not only for the current magnitude of ambiguity but also for the risk associated with its future fluctuations. As such, both the ambiguity level and volatility help raise asset premia and accommodate richer dynamics of asset prices. With a novel measure for the ambiguity level, I show that the estimated model is able to explain a wide range of asset markets anomalies, including the equity premium puzzle, the risk-free rate puzzle, the credit spread puzzle, and the expectations puzzle. In particular, this paper establishes both theoretical and empirical linkages of ambiguity with the unspanned predictability in the Treasury market. Furthermore, the proposed ambiguity measure is found to exhibit significant predictive power for excess returns on equities and bonds as well as for corporate yield spreads, a finding that justifies uncertainty channels highlighted in the model.The remaining four essays are based on work that is coauthored with Professor Jingzhi Huang. In the second chapter, we provide new and robust evidence on the power of macro variables for forecasting bond risk premia by using a recently developed model selection method--the supervised adaptive group "leastabsolute shrinkage and selection operator" (lasso) approach. We identify a single macro factor that can not only subsume the macro factors documented in the existing literature but also can substantially raise their forecasting power for future bond excess returns. Specifically, we find that the new macro factor, a linear combination of four group factors (including employment, housing, and price indices), can explain the variation in excess returns on bonds with maturities ranging from 2 to 5 years up to 43%. The new factor is countercyclical and furthermore picks up unspanned predictability in bond excess returns. Namely, the new macro factor contains substantial information on expected excess returns (as well as expected future short rates) but has negligible impact on the cross section of bond yields.In the third essay, we document a number of new empirical findings about the dynamic behavior and economic determinants of risk premia on real bonds. Specifically, we find that the real bond risk premium changes over time and fluctuates between positive and negative values. We also find that the real term structure itself contains a component that drives risk premia but is undetectable from cross section of bond yields. In addition, we present evidence on the link between real bond premia and macroeconomic variables. More specifically, we find that macro factors associated with real estate and consumer income and expenditure can capture a large portion of forecastable variation in excess returns on real bonds. These empirical findings have important implications for both affine term structure models and consumption-based asset pricing models of real bonds.The fourth essay provides new insights into the equity-credit market integration puzzle. Empirical evidence has documented that while variables suggested by structural credit risk models can explain only a small portion of corporate bond spread changes (Collin-Dufresne, Goldstein, and Martin 2001), these models provide quite accurate predictions of hedge ratios for corporate bond returns (Schaefer and Strebulaev 2008). These two stylized facts together are often considered to have conflicting implications for the level of integration between equity and credit markets -- given the fundamental relationship between corporate bond spread changes and returns. we provide a rational explanation of this anomaly by demonstrating that the two aforementioned seemingly conflicting findings can be reconciled with each other within the standard structural modeling framework. In particular, we show empirically that sensitivities of spread changes to leverage ratio or equity predicted by the Merton (1974) model are not rejected in time-series tests -- namely, the Merton hedge ratios for spread changes are too consistent with data. That is, the equity-credit market integration puzzle can be explained from a traditional hedging perspective.In the last essay, we empirically examine the hedging performance of structural models using data on corporate bond transaction prices over the period July 2002--December 2012 from the Trade Reporting and Compliance Engine (TRACE) database. While there is a large literature on the pricing performance of structural credit risk models, there is little empirical evidence on the empirical performance of these models on hedging corporate bonds. We find that the Merton (1974) model is not as useful as univariate regression models for the purpose of hedging corporate bond returns with equity. Further, for investment-grade bonds, hedging with Treasury bonds with a hedge ratio of unity is more effective than the Merton delta hedging with equity. However, we find that the Merton model is more useful for the purpose of hedging corporate bond spread changes, especially for high-yield bonds. Lastly, we also investigate the pricing performance of the Merton model. We find that on average the model overestimates (underestimates) prices (yield spreads) of bonds in our sample. Specifically, the model overestimates prices of corporate bonds by 1.87% on average. To sum, the evidence based on more recent data on transaction prices indicates that the Merton model still underpredicts yield spreads, especially for short-maturity or investment-grade bonds.

Author: Matteo Leombroni
Publisher:
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Languages : en
Pages : 0

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This thesis studies the interaction of monetary policy and financial markets. The thesis examines the impact of monetary policy shocks on the cross-section of bond prices (e.g., government and corporate bonds). It also analyzes how monetary policy interacts with the portfolios of financial intermediaries and households. In the first chapter, Heterogeneous Intermediaries and Bond Characteristics in the Transmission of Monetary Policy, together Federic Holm-Hadulla, we study the transmission of monetary policy to the corporate bond market. We show that corporate bond purchases by the central bank give rise to credit spread shocks, whereas government bond purchases mainly cause term spread shocks. The yields of bonds held by different intermediaries respond heterogeneously to the two shocks because intermediaries systematically select different types of bonds. We explain these findings through the lens of a model of the fixed-income market with multiple risk factors. Insurance companies and pension funds select into assets with high interest-rate risk exposure to match their long-duration liabilities. The mutual fund sector instead absorbs securities that carry credit risk. Different policy tools affect the market prices of risk factors differentially, thereby redistributing risks across intermediary sectors and ultimately across the households investing in them. In the second chapter, Central Bank Communication and the Yield Curve, with Andrea Vedolin, Gyuri Venter, and Paul Whelan, we study the interaction between monetary policy and sovereign bonds in the Euro area. We argue that monetary policy in the form of central bank communication can shape long-term interest rates by changing risk premia. Using high-frequency movements of default-free rates and equity, we show that monetary policy communications by the ECB on regular announcement days led to a significant yield spread between peripheral and core countries during the European sovereign debt crisis by increasing credit risk premia. We also show that central bank communication has a powerful impact on the yield curve outside of regular monetary policy days. In the third chapter, Household Portfolios, Monetary Policy, and Asset Prices, together with Ciaran Rogers, we examine the role of the household portfolio rebalancing channel for the aggregate and redistributive effects of monetary policy. The transmission of monetary policy works not only through regular income and substitution motives but also through an endogenous portfolio rebalancing effect that generates changes in equilibrium asset prices and a subsequent wealth effect on consumption.

Author: Shuo Liu
Publisher:
ISBN:
Category :
Languages : en
Pages : 215

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This dissertation consists of three chapters that study dealer's endogenous search effort in over-the-counter (OTC) financial markets and its effect on asset's liquidity risk in U.S. corporate bond markets. In Chapter 1, I study dealer's search intensity using a transaction-level data set on U.S. corporate bonds. The main target of this chapter is to test whether dealer's search intensity is endogenously determined by their idiosyncratic states and how search intensity affects market efficiency. Existing literatures commonly do not consider dealer's continuous adjustment of search intensity in search-and-match models and there is no paper using transaction-level data to estimate the dealer-level state-dependent search intensity. In this paper, I propose a search-and-match model with dealers' endogeneous and state-dependent search intensity and estimate it using the TRACE data for the U.S. corporate bond market. I find that: [1] if we rank all dealers by their private valuations for holding the bond, the dealer of the middle-level private valuation will choose the highest level of search intensity, and she works as the "dealer of dealers" to reallocate bond positions from the low-type dealers to the high-type dealers; [2] the estimated model gives us a quantitative evaluation of the inefficiency due to the decentralized market structure. At the average level across all sub-markets in our sample, the model estimates that dealers' search cost is 0.75% of bond's face value, and there is on average 8.64% of bond positions being misallocated, comparing with a counterfactual frictionless market. In conclusion, the decentralized market structure generates 8.96% welfare loss relative to the frictionless one. In Chapter 2, I study the correlation between corporate bond's misallocation among dealers and liquidity risk. This chapter bridges the literature on search-and-match models and the literature on explaining the non-default component of corporate bond's credit spread variations. In this paper, I propose a measure of bond's misallocation among dealers. This measure is based on a structural search-and-match model, and is defined as the cross-sectional covariance of dealers' idiosyncratic private valuations for holding the bond and their actual inventory positions in the bond. Using the TRACE data for the U.S. corporate bond market, I construct a panel data which contains yearly series of empirical estimates of bond's misallocation and liquidity risk, and verify that: at the bond level, a higher magnitude of misallocation among the dealers is associated with a higher magnitude of liquidity risk. This finding gives a preliminary market microstructural evidence supporting that: the distribution of market maker's states correlates with the magnitude of asset's liquidity risk. In Chapter 3, I theoretically study the social optimal policy function of dealer's meeting technology in over-the-counter markets. This chapter contributes to the existing literature by considering the dealer-level state-dependent meeting technology in a random search model and obtaining explicit-form solutions of the social optimal policy functions. In the model, I allow the agents (dealers) to freely adjust their meeting technologies based on two types of idiosyncratic states: asset position and liquidity need. I find that in the social optimal policy functions, there is no intermediation in the sense that no dealer will choose to search simultaneously on both the buy side and sell side of the market. This result applies for a general form of search-cost function.