TY - JOUR

T1 - Risk premia in covered bond markets

AU - Prokopczuk, Marcel

AU - Vonhoff, Volker

PY - 2012/9/1

Y1 - 2012/9/1

N2 - In this article, we conduct a detailed analysis of covered bond yield spreads. Our study yields several interesting findings. First, we demonstrate that developments in the real estate sector-and thus the value of the cover pool-are of minor relevance for the pricing of mortgage covered bonds during stable market conditions, but they become highly relevant during periods of economic distress. This makes intuitive sense, as the likelihood of the issuers' default is higher and thus the value of the cover pool becomes of great importance. This finding also shows the important distinction between covered bonds and MBS, which are more dependent on the development of the underlying portfolio. Second, after controlling for tax, liquidity, and credit risk effects, a significant difference can be attributed to the legislative framework. During normal times, the size of this difference is small, but it becomes much larger during crises. Third, general country-specific market conditions proxied by equity market performance are always relevant and explain a substantial fraction of variation in spreads. During crises, however, developments in the real estate market are much more important. Fourth, tax effects are relevant only in normal market periods, and fifth, liquidity is always an important factor, especially in turbulent times. Overall, we conclude that covered bond yield spreads are not heavily impacted by the quality of the cover assets and the legislative framework during stable market periods. However, these factors gain highly significant importance during economic turbulence. Covered bonds are often regarded as an effective refinancing vehicle for banks and are therefore considered to increase economic stability during crises. However, we have found that this is highly dependent on the respective regulatory framework. The German and French covered bond legislation should be considered exemplary and serve as a blueprint for covered bond legislation in other countries.

AB - In this article, we conduct a detailed analysis of covered bond yield spreads. Our study yields several interesting findings. First, we demonstrate that developments in the real estate sector-and thus the value of the cover pool-are of minor relevance for the pricing of mortgage covered bonds during stable market conditions, but they become highly relevant during periods of economic distress. This makes intuitive sense, as the likelihood of the issuers' default is higher and thus the value of the cover pool becomes of great importance. This finding also shows the important distinction between covered bonds and MBS, which are more dependent on the development of the underlying portfolio. Second, after controlling for tax, liquidity, and credit risk effects, a significant difference can be attributed to the legislative framework. During normal times, the size of this difference is small, but it becomes much larger during crises. Third, general country-specific market conditions proxied by equity market performance are always relevant and explain a substantial fraction of variation in spreads. During crises, however, developments in the real estate market are much more important. Fourth, tax effects are relevant only in normal market periods, and fifth, liquidity is always an important factor, especially in turbulent times. Overall, we conclude that covered bond yield spreads are not heavily impacted by the quality of the cover assets and the legislative framework during stable market periods. However, these factors gain highly significant importance during economic turbulence. Covered bonds are often regarded as an effective refinancing vehicle for banks and are therefore considered to increase economic stability during crises. However, we have found that this is highly dependent on the respective regulatory framework. The German and French covered bond legislation should be considered exemplary and serve as a blueprint for covered bond legislation in other countries.

UR - http://www.scopus.com/inward/record.url?scp=84867833015&partnerID=8YFLogxK

U2 - 10.3905/jfi.2012.22.2.019

DO - 10.3905/jfi.2012.22.2.019

M3 - Article

AN - SCOPUS:84867833015

VL - 22

SP - 19

EP - 29

JO - Journal of Fixed Income

JF - Journal of Fixed Income

SN - 1059-8596

IS - 2

ER -