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

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  • ROBERTO BLANCO
  • SIMON BRENNAN
  • IAN W. MARSH

Abstract

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.

Suggested Citation

  • Roberto Blanco & Simon Brennan & Ian W. Marsh, 2005. "An Empirical Analysis of the Dynamic Relation between Investment‐Grade Bonds and Credit Default Swaps," Journal of Finance, American Finance Association, vol. 60(5), pages 2255-2281, October.
    • Handle: RePEc:bla:jfinan:v:60:y:2005:i:5:p:2255-2281
    DOI: 10.1111/j.1540-6261.2005.00798.x
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