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

Record type: Conference or Workshop Item (Other)

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

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Citation

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

More information

Published date: 11 March 2011
Venue - Dates: 4th Financial Risks International Forum, France, 2011-03-10 - 2011-03-11

Identifiers

Local EPrints ID: 193275
URI: http://eprints.soton.ac.uk/id/eprint/193275
PURE UUID: 37ebc542-b539-49be-86fa-40893092e1a9

Catalogue record

Date deposited: 13 Jul 2011 09:25
Last modified: 18 Jul 2017 11:29

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Contributors

Author: Giovanni Calice
Author: Christos Ioannidis
Author: Ronghui Miao

University divisions


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