Get 20M+ Full-Text Papers For Less Than $1.50/day. Start a 14-Day Trial for You or Your Team.

Learn More →

A Credit Spread Puzzle for Reduced-Form Models

A Credit Spread Puzzle for Reduced-Form Models Reduced-form models of default calibrated to expected default losses and comovements between default losses and an equity-based pricing kernel generate CDS spreads that tend to fall below historical values. In frictionless markets, resolving this credit spread puzzle requires credit-market investors, especially those in high-quality debt, to be more risk adverse than equity-market investors. In the absence of market segmentation, however, the puzzle points to a liquidity component that, depending on the model specification, can account for more than half of historical CDS spreads. These findings caution against fitting reduced-form models to CDS spreads without accounting for market segmentation or frictions. (JEL G12, G13, G22, G24) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Asset Pricing Studies Oxford University Press

A Credit Spread Puzzle for Reduced-Form Models

Berndt, Antje
The Review of Asset Pricing Studies , Volume 5 (1) – Jun 24, 2015
Download PDF
44 pages

Loading next page...
 
/lp/oxford-university-press/a-credit-spread-puzzle-for-reduced-form-models-ZPL2eOD55Y

References (66)

Publisher
Oxford University Press
Copyright
The Author 2015. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oup.com
ISSN
2045-9920
eISSN
2045-9939
DOI
10.1093/rapstu/rav002
Publisher site
See Article on Publisher Site

Abstract

Reduced-form models of default calibrated to expected default losses and comovements between default losses and an equity-based pricing kernel generate CDS spreads that tend to fall below historical values. In frictionless markets, resolving this credit spread puzzle requires credit-market investors, especially those in high-quality debt, to be more risk adverse than equity-market investors. In the absence of market segmentation, however, the puzzle points to a liquidity component that, depending on the model specification, can account for more than half of historical CDS spreads. These findings caution against fitting reduced-form models to CDS spreads without accounting for market segmentation or frictions. (JEL G12, G13, G22, G24)

Journal

The Review of Asset Pricing Studies – Oxford University Press

Published: Jun 24, 2015

There are no references for this article.