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Conference of 2007
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his article presents joint econometric analysis of interest rate risk, issuer-specific risk (credit risk) and bond-specific risk (liquidity risk) in a reduced-form framework. Although our model includes correlation between interest rate risk and issuer-specific risk, it allows sequential estimation of the risk-free term structure parameters and the issuer-specific as well as bond-specific components. Within the Bayesian framework we develop a methodology to estimate the model parameters and to separate the different components of risk. Via Markov Chain Monte Carlo methods and data augmentation we infer a risk-free term structure process from swap market data and, based on these estimates, estimate issuer-specific and bond-specific risk from corporate bond data in the German market. We find that bond-specific risk plays a crucial role in the pricing of corporate bonds. As regards issuer-specific risk, we find a strong impact of time, the (level and slope of the) risk-free term structure, the KMV distance to default and the lagged component and only a weak impact of the stock market variables (stock market index changes, returns of this particular stock, stock market volatility) on the issuer-specific component while there is no impact of the debt to value ratio. As regards bond-specific risk, we observe a strong impact of level and slope of the risk-free term structure and the lagged terms as well as a weak impact of the stock market variables and the distance to default on the bond-specific component without any impact of time or debt to value ratio. Among the bonds analyzed we observe large differences between the relative influence of issuer-specific vs. bond-specific spread and its volatility.
Abstract
The Risk Microstructure of Corporate Bonds: A Bayesian Analysis of the German Corporate Bond Market
Sögner, Leopold; Frühwirth, Manfred; Schneider, Paulhis article presents joint econometric analysis of interest rate risk, issuer-specific risk (credit risk) and bond-specific risk (liquidity risk) in a reduced-form framework. Although our model includes correlation between interest rate risk and issuer-specific risk, it allows sequential estimation of the risk-free term structure parameters and the issuer-specific as well as bond-specific components. Within the Bayesian framework we develop a methodology to estimate the model parameters and to separate the different components of risk. Via Markov Chain Monte Carlo methods and data augmentation we infer a risk-free term structure process from swap market data and, based on these estimates, estimate issuer-specific and bond-specific risk from corporate bond data in the German market. We find that bond-specific risk plays a crucial role in the pricing of corporate bonds. As regards issuer-specific risk, we find a strong impact of time, the (level and slope of the) risk-free term structure, the KMV distance to default and the lagged component and only a weak impact of the stock market variables (stock market index changes, returns of this particular stock, stock market volatility) on the issuer-specific component while there is no impact of the debt to value ratio. As regards bond-specific risk, we observe a strong impact of level and slope of the risk-free term structure and the lagged terms as well as a weak impact of the stock market variables and the distance to default on the bond-specific component without any impact of time or debt to value ratio. Among the bonds analyzed we observe large differences between the relative influence of issuer-specific vs. bond-specific spread and its volatility.