Credit Risk in Covered Bonds

Covered bonds are a promising alternative for prime mortgage securitization. In this paper, we explore risk premia in the covered bond market and particularly investigate whether and how credit risk is priced. In extant literature, yield spreads between high-quality covered bonds and government bonds are often interpreted as pure liquidity premia. In contrast, we show that although liquidity is important, it is not the exclusive risk factor. Using a hand-collected data set of cover pool information, we fi nd that the credit quality of the cover assets is an important determinant of covered bond yield spreads. This e ffect is particular strong in times of fi nancial turmoil and has a signi ficant influence on the issuer's re financing cost