A Markov switching unobserved component analysis of the CDX index term premium


Calice, Giovanni, Ioannidis, Christos and Miao, Ronghui (2011) A Markov switching unobserved component analysis of the CDX index term premium. 4th Financial Risks International Forum, Paris, France, 10 - 11 Mar 2011.

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Description/Abstract

Using a Markov switching unobserved component model we decompose the term premium of the North American CDX investment grade index (CDX-IG) into a permanent and a stationary component. We explain the evolution of the two components in relating them to monetary policy and stock market variables. We establish that the inversion of the CDX index term premium is induced by sudden changes in the unobserved stationary component, which represents the evolution of the fundamentals underpinning the probability of default in the economy. We _nd strong evidence that the unprecedented monetary policy response from the Fed during the crisis period was e_ective in reducing market uncertainty and helped to steepen the term structure of the index thereby mitigating systemic risk concerns. The impact of stock market volatility in attening the term premium, as captured by the VIX index, was substantially more robust in the crisis period. We also show that equity returns make a substantial contribution to the term premium over the entire sample period

Item Type: Conference or Workshop Item (Invited Paper)
Related URLs:
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Divisions: University Structure - Pre August 2011 > School of Management
ePrint ID: 193275
Date Deposited: 13 Jul 2011 09:25
Last Modified: 27 Mar 2014 19:44
URI: http://eprints.soton.ac.uk/id/eprint/193275

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