Spurious Cross-Sectional Dependence in Credit Spread Changes

In order to understand the lingering credit risk puzzle and the apparent segmentation of the stock market from credit markets, we need to be able to assess the strength of the cross-sectional dependence in credit spreads. This turns out to be a non-trivial task due to the extreme data sparsity that...

Full description

Saved in:
Bibliographic Details
Published inIDEAS Working Paper Series from RePEc
Main Authors Jaskowski, M, McAleer, MJ
Format Paper
LanguageEnglish
Published St. Louis Federal Reserve Bank of St. Louis 01.01.2018
Subjects
Bond issues
Purchasing power parity
Sparsity
Online AccessGet full text

Cover

More Information
Summary:In order to understand the lingering credit risk puzzle and the apparent segmentation of the stock market from credit markets, we need to be able to assess the strength of the cross-sectional dependence in credit spreads. This turns out to be a non-trivial task due to the extreme data sparsity that is typical for any panel of credit spreads that is extracted from corporate bond transactions. The problem of data sparsity has led to some erroneous conclusions in the literature, including inferences that have been drawn from spurious cross-sectional dependence in credit spread changes. Understanding the pitfalls leads to a new and improved estimator of the latent factor in credit spread changes and its characteristics.