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Collateral affects return risk: evidence from the euro bond market

  • Stig Helberg
  • Snorre LindsetEmail author
Article
  • 6 Downloads

Abstract

Covered bonds and senior bonds are prominent securities in the euro bond market. Senior bonds are unsecured, while covered bonds are secured—backed by collateral. Our results show that the presence of collateral reduces the total risk in individual bonds by more than 70%. Compared to diversified portfolios of senior bonds, diversified portfolios of covered bonds have a significantly lower level of systematic risk. However, the fraction of systematic risk to total risk is higher for covered bonds. By decomposing the variance of bond returns, we find that around 33% of the risk in senior bonds is systematic, versus 53% in covered bonds. Both types of bonds contain instrument-specific risk.

Keywords

Covered bonds Senior bonds Systematic risk Unsystematic risk Instrument-specific risk 

JEL Classification

G19 G21 

Notes

Acknowledgements

We are grateful for valuable comments and suggestions from Lars-Erik Borge, Eric Duca, Hans Marius Eikseth, Egil Matsen, Aksel Mjøs, Kjell Nyborg, two anonymous referees, and seminar participants at NTNU, at the University of Central Florida, and at the 2017 Paris Financial Management Conference. We are particularly grateful for the data assistance provided by Ivar Pettersen. The paper was partially written while Lindset was a visiting scholar at the University of Central Florida.

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Copyright information

© Swiss Society for Financial Market Research 2020

Authors and Affiliations

  1. 1.Norwegian University of Science and TechnologyTrondheimNorway

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