Abstract
This paper compares the pricing of credit risk in the bond market and the fast-growing credit default swap (CDS) market. The cointegration test confirms that the theoretical parity relationship between the two credit spreads holds as a long-run equilibrium condition. Nevertheless, substantial deviation from the parity can arise in the short run. The panel data study and the VECM analysis both suggest that the deviation is largely due to the higher responsiveness of CDS premia to changes in credit conditions. Moreover, it exhibits a certain degree of persistence in that only 10% of price discrepancies can be removed within a business day.
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Zhu, H. An Empirical Comparison of Credit Spreads between the Bond Market and the Credit Default Swap Market. J Finan Serv Res 29, 211–235 (2006). https://doi.org/10.1007/s10693-006-7626-x
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DOI: https://doi.org/10.1007/s10693-006-7626-x