European Asset Swap Spreads and the Credit Crisis

We examine time-varying behavior and determinants of asset swap (ASW) spreads for 23 iBoxx European corporate bond indexes stratified by industry, credit rating and seniority. The results of a Markov switching model suggest that ASW spreads exhibit regime dependent behavior. The evidence is particularly strong for Financial and Corporates Subordinated indexes. Stock market volatility determines ASW spread changes in turbulent periods whereas stock returns tend to affect spread changes in periods of lower volatility. Whilst market liquidity affects spreads only in turbulent regimes the level of interest rates is an important determinant of spread changes in both regimes. Finally, we identify stock returns, lagged ASW spread levels, and lagged volatility of ASW spreads as major drivers of the regime shifts