Article2019

Limited Investment Capital and Credit Spreads

125 citations0/0 files storedThe Journal of Finance

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Credit Risk and Financial Regulations Financial Markets and Investment Strategies Stochastic processes and financial applications

Abstract

ABSTRACT Using proprietary credit default swap (CDS) data, I investigate how capital shocks at protection sellers impact pricing in the CDS market. Seller capital shocks—measured as CDS portfolio margin payments—account for 12% of the time‐series variation in weekly spread changes, a significant amount given that standard credit factors account for 18% during my sample. In addition, seller shocks possess information for spreads that is independent of institution‐wide measures of constraints. These findings imply a high degree of market segmentation, and suggest that frictions within specialized financial institutions prevent capital from flowing into the market at shorter horizons.

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References

1991Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations 1974ON THE PRICING OF CORPORATE DEBT: THE RISK STRUCTURE OF INTEREST RATES*1981Biases in Dynamic Models with Fixed Effects 1995The Limits of Arbitrage 1999By Force of Habit: A Consumption‐Based Explanation of Aggregate Stock Market Behavior 1999Modeling Term Structures of Defaultable Bonds 2001The Determinants of Credit Spread Changes 2004Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market

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