How is Credit Risk Priced in the German Market for Structured Products?

Abstract

Structured retail products are unsecured bonds subject to the bankruptcy risk of the issuer. We analyze the price-setting policy of issuers with respect to this credit risk. Using a long-term data set of discount certificates in the German market, we find that (i) quoted prices do depend on issuer credit risk, but (ii) this dependency is under-proportional. Hence, retail investors are only partially compensated for bearing issuer credit risk. A long-term analysis covering the global financial crisis, the European debt crisis, the succeeding calm period, and the coronavirus crisis provides evidence for the attention hypothesis: When credit risk has left the focus of retail investors, they are no longer compensated for it, even if it becomes substantial as in the early months of the coronavirus crisis.

Keywords: structured retail products, banking, retail investors, credit risk, option pricing, structural model, financial crisis, counterparty risk, vulnerable derivatives

JEL Classification: G01, G21, G33