Default and Liquidity Regimes in the Bond Market During the 2002-2012 Period
Canadian Journal of Economics, Forthcoming
39 Pages Posted: 21 Aug 2013 Last revised: 17 Sep 2013
Date Written: September 16, 2013
Using a real-time random regime shift technique, we identify and discuss two different regimes in the dynamics of credit spreads during 2002-2012: a liquidity regime and a default regime. Both regimes contribute to the patterns observed in credit spreads. The liquidity regime seems to explain the predictive power of credit risk on the 2007-2009 NBER recession, whereas the default regime drives the persistence of credit spreads over the same recession. Our results complement the recent dynamic structural models as well as monetary and credit supply effects models by empirically supporting two important patterns in credit spreads: the persistence and the predictive ability toward economic downturns.
Keywords: Credit spread, credit default swaps, real-time regime detection, market risk, liquidity cycle, default cycle, credit cycle, NBER economic cycle
JEL Classification: C32, C52, C61, G12, G13
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