A Markov switching unobserved component analysis of the CDX index term premium

Giovanni Calice, Christos Ioannidis, RongHui Miao

Research output: Contribution to journalArticle

Abstract

Using a Markov switching unobserved component model we decompose the term premium of the North American CDX index into a permanent and a stationary component. We establish that the inversion of the CDX term premium is induced by sudden changes in the unobserved stationary component, which represents the evolution of the fundamentals underpinning the probability of default in the economy. We find evidence that the monetary policy response from the Fed during the crisis period was effective in reducing the volatility of the term premium. We also show that equity returns make a substantial contribution to the term premium over the entire sample period.
Original languageEnglish
Pages (from-to)189-204
Number of pages16
JournalInternational Review of Financial Analysis
Volume44
Early online date16 Feb 2016
DOIs
Publication statusPublished - Mar 2016

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Bibliographical note

© 2016, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/

Keywords

  • CDX index
  • Markov switching
  • state space variance decomposition
  • term premium

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