The authors investigate the phenomenon that past winners in the stock market are potential future winners in the European bond market. By using a data set of EUR-denominated bonds for the investment grade (IG) and high yield (HY) market since 2000, the authors show that the stock market leads the bond market as well as rating changes. The authors design long-only strategies with strong equity momentum exposure. A trading strategy based on these findings has an alpha of up to 1.77% (6.93%) in IG (HY). Firms with positive (negative) equity momentum have an improving (deteriorating) rating in the future. This leads to the conclusion that an underreaction of the bond market to the firm-specific information about changing default risk is a likely source of the spillover effect. TOPICS: Exchanges/markets/clearinghouses, fixed income and structured finance Key Findings • We find a strong positive relationship between equity momentum and future returns for EUR-denominated corporate bonds. • Our strategy leads to alphas up to 1.77% (6.93%) in investment grade (high yield). • Equity momentum is able to screen out bonds that are being downgraded within the next year.
{"title":"Equity Momentum in European Credits","authors":"Hendrik Kaufmann, Philip Messow","doi":"10.2139/ssrn.3436776","DOIUrl":"https://doi.org/10.2139/ssrn.3436776","url":null,"abstract":"The authors investigate the phenomenon that past winners in the stock market are potential future winners in the European bond market. By using a data set of EUR-denominated bonds for the investment grade (IG) and high yield (HY) market since 2000, the authors show that the stock market leads the bond market as well as rating changes. The authors design long-only strategies with strong equity momentum exposure. A trading strategy based on these findings has an alpha of up to 1.77% (6.93%) in IG (HY). Firms with positive (negative) equity momentum have an improving (deteriorating) rating in the future. This leads to the conclusion that an underreaction of the bond market to the firm-specific information about changing default risk is a likely source of the spillover effect. TOPICS: Exchanges/markets/clearinghouses, fixed income and structured finance Key Findings • We find a strong positive relationship between equity momentum and future returns for EUR-denominated corporate bonds. • Our strategy leads to alphas up to 1.77% (6.93%) in investment grade (high yield). • Equity momentum is able to screen out bonds that are being downgraded within the next year.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"30 1","pages":"29 - 44"},"PeriodicalIF":0.0,"publicationDate":"2019-08-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"47106711","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The value effect is one of the most well-studied and evidenced market factors in equities. However, there has not been a widely accepted definition of the value factor in fixed income. In this article, the authors put forward their approach to the value factor by using a model-implied OAS framework to identify under- and overvalued securities. They evaluate the model with a highly controlled testing and reweighting mechanism to best preserve the credit, maturity, and industry characteristics to filter out the noise from undesired sources. Empirical results across various global corporate bond markets show that the value factor could unlock additional returns while accompanied by higher volatilities as a result of its cyclicality. The framework applied in the article can also be extended to test the effectiveness of other fixed income factors. TOPICS: Analysis of individual factors/risk premia, factor-based models, factors, risk premia
{"title":"Fixed-Income Value Factor","authors":"Shawn Shen, Arom Pathammavong, A. Chen","doi":"10.3905/jfi.2019.1.067","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.067","url":null,"abstract":"The value effect is one of the most well-studied and evidenced market factors in equities. However, there has not been a widely accepted definition of the value factor in fixed income. In this article, the authors put forward their approach to the value factor by using a model-implied OAS framework to identify under- and overvalued securities. They evaluate the model with a highly controlled testing and reweighting mechanism to best preserve the credit, maturity, and industry characteristics to filter out the noise from undesired sources. Empirical results across various global corporate bond markets show that the value factor could unlock additional returns while accompanied by higher volatilities as a result of its cyclicality. The framework applied in the article can also be extended to test the effectiveness of other fixed income factors. TOPICS: Analysis of individual factors/risk premia, factor-based models, factors, risk premia","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"21 - 43"},"PeriodicalIF":0.0,"publicationDate":"2019-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jfi.2019.1.067","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"47330623","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-06-30DOI: 10.3905/jfi.2019.29.1.077
Hyeongjun Kim, Hoon Cho, Doojin Ryu
A construction surety bond helps a development project to proceed smoothly. This financial product has supported the rapid economic growth of several emerging markets, including the Republic of Korea. In this study, by using a unique and high-quality dataset, the authors analyze construction surety bonds to estimate their default probabilities. The results have several empirical implications. First, firm characteristics, such as firm size and leverage ratio, influence the surety bond default risk; the safety and liquidity measure are especially robust indicators. The result also confirms that account receivables can increase the default risk. Second, endogenous variables of the surety bond are also robust indicators of default. Because a construction surety bond itself has additional information about a company starting a new construction project, those variables can contribute to indicating default risk. Finally, default forecasting based on this model has much greater forecasting power than models based on the credit rating. TOPICS: Project finance, statistical methods, credit risk management, emerging markets
{"title":"Default Risk Characteristics of Construction Surety Bonds","authors":"Hyeongjun Kim, Hoon Cho, Doojin Ryu","doi":"10.3905/jfi.2019.29.1.077","DOIUrl":"https://doi.org/10.3905/jfi.2019.29.1.077","url":null,"abstract":"A construction surety bond helps a development project to proceed smoothly. This financial product has supported the rapid economic growth of several emerging markets, including the Republic of Korea. In this study, by using a unique and high-quality dataset, the authors analyze construction surety bonds to estimate their default probabilities. The results have several empirical implications. First, firm characteristics, such as firm size and leverage ratio, influence the surety bond default risk; the safety and liquidity measure are especially robust indicators. The result also confirms that account receivables can increase the default risk. Second, endogenous variables of the surety bond are also robust indicators of default. Because a construction surety bond itself has additional information about a company starting a new construction project, those variables can contribute to indicating default risk. Finally, default forecasting based on this model has much greater forecasting power than models based on the credit rating. TOPICS: Project finance, statistical methods, credit risk management, emerging markets","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":" ","pages":"77 - 87"},"PeriodicalIF":0.0,"publicationDate":"2019-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"48144217","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-06-30DOI: 10.3905/jfi.2019.29.1.055
Seungho Baek, Kwan Yong Lee, Mina Glambosky
The authors decompose a simple cross-country interest rate differential into three cross-country differential factors, originated from the Nelson–Siegel model. Results suggest that return premiums for carry trades are highly associated with parallel yield curve shifts in investment currencies against the US yield curve. Currency portfolios based on cross-country yield curve gap can be profitable, with lowest tercile portfolios yielding sizable risk-adjusted returns adjusted for transaction costs. The authors’ model identifies higher currency carry returns for hedge funds when cross-country yield curves exhibit a wide interest gap over all maturities and finds that investment currency yields have greater curvature relative to funding currency yields. TOPICS: Currency, performance measurement, global markets
{"title":"Dynamic Risk Factors in Carry Trades","authors":"Seungho Baek, Kwan Yong Lee, Mina Glambosky","doi":"10.3905/jfi.2019.29.1.055","DOIUrl":"https://doi.org/10.3905/jfi.2019.29.1.055","url":null,"abstract":"The authors decompose a simple cross-country interest rate differential into three cross-country differential factors, originated from the Nelson–Siegel model. Results suggest that return premiums for carry trades are highly associated with parallel yield curve shifts in investment currencies against the US yield curve. Currency portfolios based on cross-country yield curve gap can be profitable, with lowest tercile portfolios yielding sizable risk-adjusted returns adjusted for transaction costs. The authors’ model identifies higher currency carry returns for hedge funds when cross-country yield curves exhibit a wide interest gap over all maturities and finds that investment currency yields have greater curvature relative to funding currency yields. TOPICS: Currency, performance measurement, global markets","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"55 - 75"},"PeriodicalIF":0.0,"publicationDate":"2019-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"44364444","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-06-30DOI: 10.3905/jfi.2019.29.1.006
Louis H. Ederington, Jeremy C. Goh, Yen Teik Lee, Lisa (Zongfei) Yang
The Dodd–Frank Act (Section 939B) enacted in 2010 repealed the exemption of credit rating agencies (CRAs) from Regulation Fair Disclosure. Testing whether CRAs continue to provide new information to the market after the repeal, the authors find that the significant prerepeal stock price responses to rating changes disappear after the regime change. Bond price reactions, however, remain significant. These results are even more significant at the investment–speculative boundary. Evidence suggests that CRAs served as a conduit for transmitting private information before the repeal and that the continued bond price reactions are likely due to regulations favoring higher-rated bonds. TOPICS: Fixed income and structured finance, information providers/credit ratings
{"title":"Are Bond Ratings Informative? Evidence from Regulatory Regime Changes","authors":"Louis H. Ederington, Jeremy C. Goh, Yen Teik Lee, Lisa (Zongfei) Yang","doi":"10.3905/jfi.2019.29.1.006","DOIUrl":"https://doi.org/10.3905/jfi.2019.29.1.006","url":null,"abstract":"The Dodd–Frank Act (Section 939B) enacted in 2010 repealed the exemption of credit rating agencies (CRAs) from Regulation Fair Disclosure. Testing whether CRAs continue to provide new information to the market after the repeal, the authors find that the significant prerepeal stock price responses to rating changes disappear after the regime change. Bond price reactions, however, remain significant. These results are even more significant at the investment–speculative boundary. Evidence suggests that CRAs served as a conduit for transmitting private information before the repeal and that the continued bond price reactions are likely due to regulations favoring higher-rated bonds. TOPICS: Fixed income and structured finance, information providers/credit ratings","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"19 - 6"},"PeriodicalIF":0.0,"publicationDate":"2019-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"44677099","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-06-30DOI: 10.3905/jfi.2019.29.1.001
Stanley J. Kon
{"title":"Editor’s Letter","authors":"Stanley J. Kon","doi":"10.3905/jfi.2019.29.1.001","DOIUrl":"https://doi.org/10.3905/jfi.2019.29.1.001","url":null,"abstract":"","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":" ","pages":"1"},"PeriodicalIF":0.0,"publicationDate":"2019-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"49361666","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article examines the impact of firm-level political risk on the value of creditor control, which is measured as the premium difference in the bond price and an equivalent synthetic bond without control rights. The synthetic bond is constructed from the credit default swap contract. We find empirically that the value of creditor control increases as the firm-level political risk increases, especially among firms with investment-grade ratings, large size, low leverage, or low equity volatility. This effect appears to be more pronounced among firms experiencing financial constraints or industry shocks. During periods of great partisan conflicts, the impact of firm-level political risk on the value of creditor control decreases. TOPICS: Fixed income and structured finance, credit default swaps, credit risk management, information providers/credit ratings
{"title":"The Impact of Firm-Level Political Risk on Creditor Control","authors":"Maksim Isakin, Xiaoling Pu","doi":"10.3905/jfi.2019.1.070","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.070","url":null,"abstract":"This article examines the impact of firm-level political risk on the value of creditor control, which is measured as the premium difference in the bond price and an equivalent synthetic bond without control rights. The synthetic bond is constructed from the credit default swap contract. We find empirically that the value of creditor control increases as the firm-level political risk increases, especially among firms with investment-grade ratings, large size, low leverage, or low equity volatility. This effect appears to be more pronounced among firms experiencing financial constraints or industry shocks. During periods of great partisan conflicts, the impact of firm-level political risk on the value of creditor control decreases. TOPICS: Fixed income and structured finance, credit default swaps, credit risk management, information providers/credit ratings","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"44 - 54"},"PeriodicalIF":0.0,"publicationDate":"2019-05-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jfi.2019.1.070","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"46104724","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-04-29DOI: 10.3905/jfi.2019.29.2.066
Daniel Zwirn, J. Liew, A. Ajakh
The US bond market had over $42.39 trillion of outstanding debt at the end of the third quarter of 2018, eclipsing the US stock market’s approximately $30 trillion in market capitalization. The sheer size of the bond market provides ample opportunities, as well as risks, for institutional investors. Some of these risks escape investors’ radar because of the nature of fixed income securities: low transparency, illiquidity, and over-the-counter (OTC) trading. In this article, the authors present our concerns regarding five secular changes wrought by the over-regulation of the marketplace after the financial crisis of 2008 and investors’ persistent thirst for yield. Further, although painful lessons were gleaned after the punishing 2008 financial crisis, the authors present empirical evidence that suggests that many sectors, such as auto loans and collateralized loan obligations, that were largely unscathed by this crisis may be at risk in the next downturn. This article is based on original data sources and academic research. The authors are in continuing dialogue with other experts that may further the research, and welcome interested parties to get in contact. TOPICS: Financial crises and financial market history, statistical methods Key Findings • Lack of market-making and other regulatory changes that will impede price discovery in the next downturn. • Masking of the deterioration of underlying collateral and rearview mirror analysis. • New versions of the old games played by the rating agencies. • Explosion in number of Asset-Liability mismatched structures. • Regulatory changes in compliance of financial institutions.
{"title":"This Time Is Different, but It Will End the Same Way: Unrecognized Secular Changes in the Bond Market since the 2008 Crisis That May Precipitate the Next Crisis","authors":"Daniel Zwirn, J. Liew, A. Ajakh","doi":"10.3905/jfi.2019.29.2.066","DOIUrl":"https://doi.org/10.3905/jfi.2019.29.2.066","url":null,"abstract":"The US bond market had over $42.39 trillion of outstanding debt at the end of the third quarter of 2018, eclipsing the US stock market’s approximately $30 trillion in market capitalization. The sheer size of the bond market provides ample opportunities, as well as risks, for institutional investors. Some of these risks escape investors’ radar because of the nature of fixed income securities: low transparency, illiquidity, and over-the-counter (OTC) trading. In this article, the authors present our concerns regarding five secular changes wrought by the over-regulation of the marketplace after the financial crisis of 2008 and investors’ persistent thirst for yield. Further, although painful lessons were gleaned after the punishing 2008 financial crisis, the authors present empirical evidence that suggests that many sectors, such as auto loans and collateralized loan obligations, that were largely unscathed by this crisis may be at risk in the next downturn. This article is based on original data sources and academic research. The authors are in continuing dialogue with other experts that may further the research, and welcome interested parties to get in contact. TOPICS: Financial crises and financial market history, statistical methods Key Findings • Lack of market-making and other regulatory changes that will impede price discovery in the next downturn. • Masking of the deterioration of underlying collateral and rearview mirror analysis. • New versions of the old games played by the rating agencies. • Explosion in number of Asset-Liability mismatched structures. • Regulatory changes in compliance of financial institutions.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"29 1","pages":"66 - 91"},"PeriodicalIF":0.0,"publicationDate":"2019-04-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42973694","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This study proposes a new methodology to estimate credit default swap- (CDS-) adjusted risk-free interest rates and sovereign default intensities. Government bond yields in a local currency and CDS premiums in a foreign currency are used to estimate the CDS-adjusted risk-free interest rate, which is adjusted for the default risk of a government and is immune to its correlation with the sovereign default intensity. The method is based on the fact that risk-free interest rates and sovereign default intensities in the same currency are correlated, whereas the correlations between the risk-free interest rates in a foreign currency and the default intensities are close to zero except during worldwide financial turmoil such as the European sovereign debt crisis. The methodology is applied to the German and US markets and the CDS-adjusted risk-free interest rates in US dollars and euros, and the sovereign default intensities of Germany and the United States are successfully estimated.
{"title":"Are the Risk-Free Interest Rates Correlated with Sovereign Default Intensities?","authors":"Yusho Kagraoka","doi":"10.3905/jfi.2019.1.068","DOIUrl":"https://doi.org/10.3905/jfi.2019.1.068","url":null,"abstract":"This study proposes a new methodology to estimate credit default swap- (CDS-) adjusted risk-free interest rates and sovereign default intensities. Government bond yields in a local currency and CDS premiums in a foreign currency are used to estimate the CDS-adjusted risk-free interest rate, which is adjusted for the default risk of a government and is immune to its correlation with the sovereign default intensity. The method is based on the fact that risk-free interest rates and sovereign default intensities in the same currency are correlated, whereas the correlations between the risk-free interest rates in a foreign currency and the default intensities are close to zero except during worldwide financial turmoil such as the European sovereign debt crisis. The methodology is applied to the German and US markets and the CDS-adjusted risk-free interest rates in US dollars and euros, and the sovereign default intensities of Germany and the United States are successfully estimated.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"28 1","pages":"103 - 91"},"PeriodicalIF":0.0,"publicationDate":"2019-03-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jfi.2019.1.068","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"44039930","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2019-03-31DOI: 10.3905/jfi.2019.28.4.001
Stanley J. Kon
{"title":"Editor’s Letter","authors":"Stanley J. Kon","doi":"10.3905/jfi.2019.28.4.001","DOIUrl":"https://doi.org/10.3905/jfi.2019.28.4.001","url":null,"abstract":"","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"28 1","pages":"1"},"PeriodicalIF":0.0,"publicationDate":"2019-03-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42593416","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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