An Empirical Analysis of the Dynamic Relation between Investment-Grade Bonds and Credit Default Swaps





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    • Blanco is at the Banco de España and was on secondment to the Bank of England while this paper was being written, Brennan is at the Bank of England, and Marsh is at Cass Business School, and the Cambridge Endowment for Research in Finance. He was on leave of absence at the Bank of England when this paper was being written. We would like to thank Bill Allen, Eva Catarineu, Gordon Gemmill, Charles Goodhart, Andrew Haldane, Simon Hayes, Kevin James, David Rule, Hyun Shin, Michela Vecchi, Geoffrey Wood, seminar participants at the Bank of England, Banco de España, Western Finance Association 2003, Foro de Finanzas 2003, a referee, and the editor for useful comments. Karen Goff and Andrew Paterson provided very able research assistance. CreditTrade and J.P. Morgan Securities kindly allowed us to use their credit default swap data. Numerous people at Banc of America Securities, Bloomberg, BNP Paribas, CreditTrade, Deutsche Bank, and J.P. Morgan answered our questions and corrected our misunderstandings. They know whom they are and that we are very grateful. This paper represents the views and analysis of the authors and should not be thought to represent those of the Bank of England, Monetary Policy Committee members, or the Banco de España. Any errors and omissions are our own.


We test the theoretical equivalence of credit default swap (CDS) prices and credit spreads derived by Duffie (1999), finding support for the parity relation as an equilibrium condition. We also find two forms of deviation from parity. First, for three firms, CDS prices are substantially higher than credit spreads for long periods of time, arising from combinations of imperfections in the contract specification of CDSs and measurement errors in computing the credit spread. Second, we find short-lived deviations from parity for all other companies due to a lead for CDS prices over credit spreads in the price discovery process.