An analysis of euro area sovereign CDS and their relation with government bonds by Alessandro Fontana

Preliminary and incomplete please do not cite This paper studies the behavior of the CDS-bond basis- the difference between the CDS and the bond spread- during the 2007/08 financial crisis, for a sample of investment-graded US firms. The objective is to show that during stress times asset prices depart materially farther form frictionless ideals due to funding liquidity risk faced by financial intermediaries and investors; hence, deviations from parity do not imply presence of arbitrage opportunities. We document that CDS and bond spreads have deviated from their parity condition (the basis has become persistently negative) and are no more moving together, in contrasts with what reported by other studies conducted prior to the crisis. We investigate the role played by the cost of trading the basis studying its relation with CDS and bond spreads. We find that the TED spread (Libor- 3 Month T-bill), which is our measure of the funding cost and risk of trading the basis, drives the basis dynamics, when it is negative, and also explains the difference in levels between CDS and bond spreads for lower rated entities. crisis.

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This paper recognizes that intuitively a clear understanding about security market pricing procedures from both long- and short-runs viewpoints are important to an astute investor. Here an attempt is made to identify the efficient method of empirical studies in asset pricing that are relevant under the integrated global market system. Accordingly, it has briefly reviewed recent studies in asset pricing that are particularly important from a security market standpoint under the prevailing global economic and financial market system. Through this survey using the cointegration approach one can efficiently analyze the long-run relationship between a priori variables that are considered as a proxy for systematic risk factors and security market prices from the perspective of any nation within the globe. Field of Research: Asset pricing, stock market analysis, systematic risk factors, cointegration.

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In this paper, we develop novel Markov chain Monte Carlo sampling methodology for Bayesian Cointegrated Vector Auto Regression (CVAR) models. Here we focus on two novel extensions to the sampling methodology for the CVAR posterior distribution. The first extension we develop replaces the popular sampling methodology of the griddy Gibbs sampler with an automated alternative which is based on an Adaptive Metropolis-Hastings algorithm. This is particularly relevant to automate the proposal mechanism in the MCMC algorithm in settings where griddy Gibbs is impractical such as when the dimension of the CVAR series is large, e.g. d> 5. We also treat the rank of the CVAR model as a random variable and perform joint inference on the rank and model parameters. This is achieved with a Bayesian posterior distribution defined over both the rank and the CVAR model parameters, and inference is made via a Savage-Dickey density estimator for the Bayes Factor analysis of rank.

Using mixture of distributions hypothesis, we evaluate the liquidity of the Sydney Futures Exchange with an analysis of ‘at the money ’ share price index (SPI) call options and SPI futures contracts after the introduction of electronic trading on 15 November 1999. The results show that during the proximate period up to beginning August 2000 ‘at the money’ SPI options were more liquid in times of high volatility after the SFE became automated. But the SPI futures are less liquid in times of medium to low market volatility after the automation. An examination of the price discovery process before and after automation was also incorporated into this study in testing market efficiency. Under this assumption the trading prices in the Australian Stock Exchange (ASX) and Sydney Futures Exchange (SFE) should have a long-run cointegrating relationship. The results confirm a cointegrating relationship between the two markets before and after the introduction of electronic trading supporting the semi-strong market efficiency. Our findings also indicate presence of a bi-directional lead–lag relationship between the SPI futures price and the All Ordinaries Index price before and after the introduction of electronic trading. This suggests that the electronic trading structure does not seem to greatly enhance the price discovery price of the SFE.