Abstract
We examine time-varying behavior and determinants of asset swap (ASW) spreads for 23 iBoxx European corporate bond indexes stratified by industry, credit rating and seniority. The results of a Markov switching model suggest that ASW spreads exhibit regime dependent behavior. The evidence is particularly strong for Financial and Corporates Subordinated indexes. Stock market volatility determines ASW spread changes in turbulent periods whereas stock returns tend to affect spread changes in periods of lower volatility. Whilst market liquidity affects spreads only in turbulent regimes the level of interest rates is an important determinant of spread changes in both regimes. Finally, we identify stock returns, lagged ASW spread levels, and lagged volatility of ASW spreads as major drivers of the regime shifts.
Highlights
An asset swap (ASW) is a synthetic position that combines a fixed rate bond with a fixed-to-floating interest rate swap.1 The bondholder effectively transforms the pay-off, where she pays the fixed rate and receives the floating rate consisting of LIBOR plus the ASW spread
Our findings suggest significant differences in the importance of stock market returns, changes in volatility and changes in interest rates for explaining ASW spreads from various industries
In this study we examine the time-series dynamic of credit risk based on ASW spread data for a set of 23 European iBoxx Corporate Bond indexes during the period from 1 January 2006 to 30 January 2009
Summary
An asset swap (ASW) is a synthetic position that combines a fixed rate bond with a fixed-to-floating interest rate swap. The bondholder effectively transforms the pay-off, where she pays the fixed rate and receives the floating rate consisting of LIBOR (or EURIBOR) plus the ASW spread. An asset swap (ASW) is a synthetic position that combines a fixed rate bond with a fixed-to-floating interest rate swap.. The bondholder effectively transforms the pay-off, where she pays the fixed rate and receives the floating rate consisting of LIBOR (or EURIBOR) plus the ASW spread. The ASW spread is a compensation for the default risk and corresponds to the difference between the floating part of an ASW and the LIBOR (or EURIBOR) rate. ASWs are very liquid and could be traded separately, even easier than underlying defaultable bonds (Schönbucher 2003). ASW spreads are, a bond-specific measure of credit risk implied in bond prices and yields. Asset-swapped fixed-rate bonds financed in the repo market are comparable to credit default swap (CDS) contracts (Francis, Kakodkar, and Martin 2003). ASW usually trades in a close range (see Zhu 2004; Norden and Weber 2009) and tends to be cointegrated with CDS (De Wit 2006)
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