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Working Paper
Sovereign Risk and Financial Risk
In this paper, we study the interplay between sovereign risk and global financial risk. We show that a substantial portion of the comovement among sovereign spreads is accounted for by changes in global financial risk. We construct bond-level sovereign spreads for dollar-denominated bonds issued by more than 50 countries from 1995 to 2020 and use various indicators to measure global financial risk. Through panel regressions and local projection analysis, we find that an increase in global financial risk causes a large and persistent widening of sovereign bond spreads. These effects are ...
Working Paper
Sovereign Risk and Financial Risk
In this paper, we study the interplay between sovereign risk and global financial risk. We show that a substantial portion of the comovement among sovereign spreads is accounted for by changes in global financial risk. We construct bond-level sovereign spreads for dollar-denominated bonds issued by more than 50 countries from 1995 to 2020 and use various indicators to measure global financial risk. Through panel regressions and local projection analysis, we find that an increase in global financial risk causes a large and persistent widening of sovereign bond spreads. These effects are ...
Journal Article
Trends in credit basis spreads
Market participants and policymakers were surprised by the large, prolonged dislocations in credit market basis trades during the second half of 2015 and the first quarter of 2016. In this article, we examine three explanations proposed by market participants: increased idiosyncratic risks, strategic positioning by asset managers, and regulatory changes. We find some evidence of increased idiosyncratic risk during the relevant period, but limited evidence of asset managers changing their positioning in derivative products. Although we cannot quantify the contribution of these two channels to ...
Report
Credit market choice
Which markets do institutions use to change exposure to credit risk? Using a unique data set of transactions in corporate bonds and credit default swaps (CDS) by large financial institutions, we show that simultaneous transactions in both markets are rare, with an average institution having an 11 percent probability of transacting in both the CDS and bond markets in the same entity in an average week. When institutions do transact in both markets simultaneously, they increase their speculative positions in CDS by 13 cents per dollar of bond transactions, and their hedging positions by 13 ...
Discussion Paper
Credit Market Choice
Credit default swaps (CDS) are frequently credited with being the cause of AIG’s collapse during the financial crisis. A Reuters article from September 2008, for example, notes “[w]hen you hear that the collapse of AIG […] might lead to a systemic collapse of the global financial system, the feared culprit is, largely, that once-obscure […] instrument known as a credit default swap.” Yet, despite the prominent role that CDS played during the financial crisis, little is known about how individual financial institutions utilize CDS contracts on individual companies. In a recent New ...
Working Paper
Market Effects of Central Bank Credit Markets Support Programs in Europe
Using responses of credit default swap indexes to ECB monetary policy announcements, we isolate a novel credit policy component of monetary policy surprises. We examine how such unconventional monetary policy surprises affect investor perceptions of credit risk and the functioning of primary corporate debt markets. Favorable credit surprises cause declines in uncertainty about credit risk and suggest a more stable outlook on its dynamics over the following months. Both net and gross corporate bond issuance increase as a result of favorable credit surprises, with the largest response in ...
Working Paper
Bayesian Estimation of Time-Changed Default Intensity Models
We estimate a reduced-form model of credit risk that incorporates stochastic volatility in default intensity via stochastic time-change. Our Bayesian MCMC estimation method overcomes nonlinearity in the measurement equation and state-dependent volatility in the state equation. We implement on firm-level time-series of CDS spreads, and find strong in-sample evidence of stochastic volatility in this market. Relative to the widely-used CIR model for the default intensity, we find that stochastic time-change offers modest benefit in fitting the cross-section of CDS spreads at each point in time, ...
Working Paper
Sovereign Debt and Credit Default Swaps
ow do credit default swaps (CDS) affect sovereign debt markets? The answer depends crucially on trading frictions, risk-sharing, arbitrage violations, and spillovers from secondary to primary markets. We propose a sovereign default model where investors trade bonds and CDS over the counter via directed search. CDS affect bond prices through several channels. First, CDS act as a synthetic bond. Second, CDS reduce bond-investing risks, allowing exposure to be unwound. Third, CDS availability increases trading profitability, which induces entry and reduces trading costs. Last, these direct ...