swap rates and credit quality this article presents a model for valuing claims subject to default by both contracting parties such as swaps and forwards with counterparties of different default risk the promised cash flows of a swap are discounted by a switching discount rate that at any given state and time is equal to the discount rate of the counterparty for whom the swap is currently out of the money that is a liability the impact of credit risk asymmetry and of netting is presented through both theory and numerical examples which include interest rate and currency swaps this article presents a model for valuing claims subject to default by both contracting parties such as swaps and forwards this extends the valuation model for defaultable claims proposed by duffie and singleton 1994 to cases in which the two counterparties have asymmetric default risk the extension permits a reexamination of the impact of credit risk on swap rates while the valuation model applies to all forms of contingent claims in which both contracting parties are at risk to default such as forward contracts we focus on swaps for purposes of illustration for example consider a 5 year interest rate swap between a given party paying a floating rate such as the london inter bank offered rate libor and another counterparty paying a fixed rate replacing the given fixed rate counterparty with a lower quality counterparty whose bond yields are 100 basis points higher increases the swap rate by roughly 1 basis point using our model and typical parameters for libor rate processes this credit impact on swap rates is approximately linear within the range of normally encountered credit quality for a 5 year currency swap given a foreign exchange rate with 15 percent volatility our model shows the impact of credit risk asymmetry on the market swap rate to be roughly 10 fold greater than that for interest rate swaps that is approximately 10 basis points in swap rate per 100 basis points in bond yield credit spread the main goal of this article is to provide a simple and theoretically consistent model allowing such computations

saddlepoint approximations for affine jump diffusion models abstract affine jump diffusion ajd processes constitute a large and widely used class of continuous time asset pricing models that balance tractability and flexibility in matching market data the prices of e g bonds options and other assets in ajd models are given by extended pricing transforms that have an exponential affine form these transforms have been characterized in great generality by duffie et al 2000 transform analysis and asset pricing for affine jump diffusions econometrica 68 1343 1376 calculating model prices requires inversion of these transforms and this has limited the application of ajd models to the comparatively small subclass for which the transforms are available in closed form this article seeks to widen the scope of ajd models amenable to practical application through approximate transform inversion techniques more specifically we develop the use of saddlepoint approximations for ajd models these approximations facilitate the calculation of prices in ajd models whose transforms are not available explicitly we derive and test several alternative saddlepoint approximations and find that they produce accurate prices over a wide range of parameters

horizontal carrier coordination through cooperative governance structures this paper examines how governance structures found in the trucking industry impact the coordination between a forwarder and its carriers including three cases no forwarder coordination direct contracting with shippers investor owned coordination price only contract and carrier cooperative coordination revenue sharing contract the carriers are engaged in a cournot competition where they decide upon service provision and truck investment economic theory predicts that integration of firms under oligopolistic competition always leads to a more efficient supply chain in the sense that prices decrease and quantities increase which reduces total profits this suggests that the benefit of avoiding double marginalization does not outweigh the benefit of upstream competition in the successive oligopoly case whereas both integrated and independent firms coexist the integrated chains do perform better in this paper we examine the interaction between governance structures a key decision when managing supply chains including that found in the trucking industry and shippers willingness to procure trucking services instead of producing them using a private fleet we find that cooperative governance can contribute to improved service provision reduced service price improved consumer surplus and improved profit for the carriers in equilibrium we use parameter values based on the swedish trucking industry and a larger grocery retailer acting as shipper to numerically illustrate the impact of different governance structures

pricing default swaps empirical evidence in this paper we compare market prices of credit default swaps with model prices we show that a simple reduced form model outperforms directly comparing bonds credit spreads to default swap premiums we find that the model yields unbiased premium estimates for default swaps on investment grade issuers but only if we use swap or repo rates as proxy for default free interest rates this indicates that the government curve is no longer seen as the reference default free curve we also show that the model is relatively insensitive to the value of the assumed recovery rate

modelling sovereign credit spreads with international macro factors the case of brazil 1998 2009 abstract this paper develops a macro finance model of the brazilian economy and its sovereign debt markets that allows for domestic and international macroeconomic influences as well as swings in investor confidence it finds significant evidence of common trends in the us and brazilian economies and bond markets as well as spillover effects from us inflation and business cycles to the brazilian economy the us fed funds rate influences brazilian sovereign spreads as do brazilian inflation and policy rates the brazilian confidence factor dominates the behavior of the spreads during periods of crisis and we find that it also has a powerful effect on the level and volatility of macroeconomic variables these results suggest that the macro finance approach could throw light upon the behavior of other economies that are troubled by sovereign risk

political uncertainty and public financing costs evidence from u s gubernatorial elections and municipal bond markets this research investigates how political uncertainty around u s gubernatorial elections in uences the borrowing costs of public debt measured by yields of municipal bonds our evidence from both the new issuance market and the secondary market shows that yields of municipal bonds increase sharply by 6 to 8 basis points before elections and then reverse afterward elections have more pronounced impact during economic downturns when outcomes are less predictable and when states have more outstanding debt several state institutions such as gaap budgeting spending limits and tax increase limits help to mitigate the adverse impact of political uncertainty

the relation between sovereign credit rating revisions and economic growth abstract a country s economic growth exhibits a significant response to sovereign rating changes a one notch upgrade downgrade causes an increase decline of about 0 6 0 3 in re rated countries five year average annual growth rates the results hold after accounting for other determinants of economic growth and potential endogeneity problems and are robust to the use of quarterly data changes in country rating affect economic growth via the interest rate and capital flow channels narrower sovereign bond yield spreads and increased capital inflows are associated with upgrades which stimulate re rated countries economic performance and the converse holds for downgrades

interest rate volatility the yield curve and the macroeconomy abstract this paper provides theory and evidence that a low dimensional term structure model can simultaneously price bonds and related options it shows that a component of volatility risk largely unrelated to the shape of the yield curve is a determinant of expected excess returns for holding long maturity bonds it also finds evidence for this return relationship both in the model and directly in the data through regression analysis the paper also identifies a link between corporate earnings performance and interest rate volatility providing a channel driving interest rate volatility the structure of risk in the model that gives rise to these features of volatility is distinct from that inherent in recent models with unspanned stochastic volatility

the term structure of interbank risk we infer a term structure of interbank risk from spreads between rates on interest rate swaps indexed to the london interbank offered rate libor and overnight indexed swaps we develop a tractable model of interbank risk to decompose the term structure into default and non default liquidity components from august 2007 to january 2011 the fraction of total interbank risk due to default risk on average increases with maturity at short maturities the non default component is important in the first half of the sample period and is correlated with measures of funding and market liquidity the model also provides a framework for pricing hedging and risk management of interest rate swaps in the presence of significant basis risk

exploiting the conditional density in estimating the term structure an application to the cox ingersoll and ross model we propose an empirical method that utilizes the conditional density of the state variables to estimate and test a term structure model with known price formulae using data on both discount and coupon bonds the method is applied to an extension of a two factor model due to cox ingersoll and ross 1985 cir our results show that estimates based on only bills imply unreasonably large price errors for longer maturities we reject the original cir model using a likelihood ratio test and conclude that the extended cir model also fails to provide a good description of the treasury market

the great moderation in micro labor earnings abstract between 1980 and the early 1990s the variability of labor earnings growth rates across the prime age working population fell significantly this decline and timing are consistent with other macro and micro observations about growth variability that are collectively referred to as the great moderation the variability of earnings growth is negatively correlated with age at any point in time and the u s working age population got older during this period because the baby boom was aging however the decrease in variability was roughly uniform across all age groups so population aging is not the source of the overall decline the variance of log changes also declined at multi year frequencies in such a way as to suggest that both permanent and transitory components of earnings shocks became more moderate a simple identification strategy for separating age and cohort effects shows a very intuitive pattern of permanent and transitory shocks over the life cycle and confirms that a shift over time in the stochastic process occurred even after controlling for age effects

municipal debt and marginal tax rates is there a tax premium in asset prices we study the marginal tax rate incorporated into short term municipal rates using municipal swap market data using an affine model we identify the marginal tax rate and the credit liquidity spread in 1 week tax exempt rates as well as their associated risk premia the marginal tax rate averages 38 0 and is related to stock bond and commodity returns the tax risk premium is negative consistent with the strong countercyclical nature of after tax fixed income cash flows these results demonstrate that tax risk is a systematic asset pricing factor and help resolve the muni bond puzzle

foreign debt supply in an imperfect international capital market theory and evidence abstract we investigate the determinants of foreign borrowing costs in a stochastically growing economy we find that these increase with the debt wealth ratio depending also upon the volatilities of domestic and foreign origin and the length of debt contract in addition the sensitivity of the short term debt supply to the debt wealth ratio exceeds that of long term debt and the effects of volatility on the borrowing premium growth of wealth and its volatility depend on the relative size of a direct effect and a secondary portfolio adjustment effect of the initial shock as well as the length of the debt contract panel regressions suggest that the empirical evidence generally support the theoretical predictions

pricing derivatives on financial securities subject to credit risk this article provides a new methodology for pricing and hedging derivative securities involving credit risk two types of credit risks are considered the first is where the asset underlying the derivative security may default the second is where the writer of the derivative security may default we apply the foreign currency analogy of jarrow and turnbull 1991 to decompose the dollar payoff from a risky security into a certain payoff and a spot exchange rate arbitrage free valuation techniques are then employed this methodology can be applied to corporate debt and over the counter derivatives such as swaps and caps the purpose of this article is to provide a new theory for pricing and hedging derivative securities involving credit risk two sources of credit risk are identified and analyzed the first is where the asset underlying the derivative security may default paying off less than promised this is the case for example with imbedded options on corporate debt the second is the credit risk introduced by the writer of the derivative security who may also default examples include over the counter writers of options on eurodollar futures swaps and swaptions for pricing derivative securities involving credit risk there are currently two approaches the first views these derivatives as contingent claims not on the financial securities themselves but as compound options on the assets underlying the financial securities this is the case for example with the pricing of imbedded options on corporate debt see merton 1974 1977 black and cox 1976 ho and singer 1982 chance 1990 and kim ramaswamy and sundaresan 1993 or the pricing of vulnerable options see johnson and stulz 1987 in practice however this valuation methodology is difficult to use first the assets underlying the financial security are often not tradeable and therefore their values are not observable this makes application of the theory and estimation of the relevant parameters problematic second as in the case of corporate debt all of the other liabilities of the firm senior to the corporate debt must first and simultaneously be valued this generates significant computational difficulties as a result this approach has not

the delivery option in credit default swaps abstract under standard assumptions the reduced form credit risk model is not capable of accurately pricing the two fundamental credit risk instruments bonds and credit default swaps cds simultaneously using a data set of euro denominated corporate bonds and cds our paper quantifies this mispricing by calibrating such a model to bond data and subsequently using it to price cds resulting in model cds spreads up to 50 lower on average than observed in the market an extended model is presented which includes the delivery option implicit in cds contracts emerging since a basket of bonds is deliverable in default by using a constant recovery rate standard models assume equal recoveries for all bonds and hence zero value for the delivery option contradicting this common assumption case studies of chapter 11 filings presented in the paper show that corporate bonds do not necessarily trade at equal levels following default our extension models the implied expected recovery rate of the cheapest to deliver bond and applied to data largely eliminates the mispricing calibrated recovery values lie between 8 and 47 for different obligors exhibiting strong variation among rating classes and industries a cross sectional analysis reveals that the implied recovery parameter depends on proxies for the delivery option primarily the number of available bonds and bond pricing errors no evidence is found for a direct influence of the bid ask spread notional amount coupon or rating used as proxies for bond market liquidity

modeling sovereign yield spreads a case study of russian debt we construct a model for pricing sovereign debt that accounts for the risks of both default and restructuring and allows for compensation for illiquidity using a new and relatively efficient method we estimate the model using russian dollar denominated bonds we consider the determinants of the russian yield spread the yield differential across different russian bonds and the implications for market integration relative liquidity relative expected recovery rates and implied expectations of different default scenarios this paper develops a model of the termstructure of credit spreads on sovereign bonds that accommodates i default or repudiation the sovereign announces that it will stop making payments on its debt ii restructuring or renegotiation the sovereign and the lenders agree to reduce or postpone the remaining payments and iii a regime switch such as a change of government or the default of another sovereign bond that changes the perceived risk of future defaults we build on the framework of duffie and singleton 1999 showing that cash flows promised by a sovereign bond can be discounted using a default adjusted short termdiscount rate that reflects the m ean arrival rate and associated losses in market value upon arrival of each of the aforementioned types of credit events since a sovereign credit event is often not a liquidation event the model allows for continued trading and pricing of a sovereign instrument through credit events possibly after writedowns in face value or cash distributions to creditors on credit event dates additionally we accommodate the possibility that bonds issued by the same sovereign of exactly the same type but possibly of different maturities may be priced in the market using different discount factors reasons for this may include i bond covenants may not include cross default clauses that would force upon the default of one bond the simultaneous default of other bonds of the same type but of a different maturity for various strategic reasons related to internal

expectation puzzles time varying risk premia and dynamic models of the term structure abstract linear projections of returns on the slope of the yield curve have contradicted the implications of the traditional expectations theory this paper shows that these findings are not puzzling relative to a large class of richer dynamic term structure models specifically we match all the key empirical findings reported by fama and bliss 1987 american economic review 77 4 680 692 and campbell and shiller 1991 review of economic studies 58 495 514 among others within large subclasses of affine and quadratic gaussian term structure models additionally we show that certain risk premium adjusted projections of changes in yields on the slope of the yield curve recover the coefficients of unity predicted by the models key to this matching are parameterizations of the market prices of risk that let the risk factors affect the market prices of risk directly and not only through factor volatilities the risk premiums have a simple form consistent with fama s findings on the predictability of forward rates and are also shown to be consistent with interest rate feedback rules used by a monetary authority in setting monetary policy

sovereign credit spreads abstract the paper develops a structural credit risk model to study sovereign credit risk and the dynamics of sovereign credit spreads the model features endogenous default and recovery rates that both depend on the interaction between domestic output fluctuations and global macroeconomic conditions we show that sovereigns choose to default at higher levels of economic output once global macroeconomic conditions are bad this yields to default rates and credit spreads that are substantially higher compared to normal times we derive closed form expressions for sovereign debt values and default times and focus on the dynamics of sovereign credit spreads as opposed to standard theories of sovereign debt this paper s structural model generates much richer default patterns and non linearities through regime shifts in the global macroeconomic environment moreover changes in the global environment reveal the interconnectedness of the financial system

simulated likelihood estimation of diffusions with an application to exchange rate dynamics in incomplete markets abstract we present an econometric method for estimating the parameters of a diffusion model from discretely sampled data the estimator is transparent adaptive and inherits the asymptotic properties of the generally unattainable maximum likelihood estimator we use this method to estimate a new continuous time model of the joint dynamics of interest rates in two countries and the exchange rate between the two currencies the model allows financial markets to be incomplete and specifies the degree of incompleteness as a stochastic process our empirical results offer several new insights into the dynamics of exchange rates