Authors: Chang, Chia-Chien¹; Wang, Chou-Wen²; Liao, Szu-Lang³

Source: Applied Financial Economics, Volume 19, Number 3, February 2009 , pp. 227-256(30)

Publisher: Routledge, part of the Taylor & Francis Group

Abstract:

With the intersection of market and credit risk, the first contribution is to derive the analytic formulas of the Credit Linked Notes (CLNs) and the leveraged total return CLNs issued by an Special Purpose Vehicle (SPV) or the protection buyer. The second contribution is to prove that the values of structured CLNs issued by an SPV are higher than the ones issued by the protection buyer. When the credit quality of the reference obligation and protection buyer becomes worse or the leverage effect is higher, it is a superior solution for the structured CLNs issued through an SPV. Third, the empirical results of credit spreads do not incorporate the correlation coefficient of spot rate and market index into their regression models and show that they are positively correlated with the volatilities of spot rate and return on market index; however, we find that the relationship among them depends on the sign of correlation coefficient of spot rate and equity index market. Finally, using the differences in the maturities of the note and the reference obligation as the proxy for basis risk measure, we demonstrate that the purpose of the SPV is not used to eliminate the basis risk but the credit risk of protection buyer.

Document Type: Research article

DOI: http://dx.doi.org/10.1080/09603100701765190

Affiliations: 1: Department of Finance, National Sun Yat-sen University, Taiwan 2: Department of Risk Management and Insurance, National Kaohsiung First University of Science and Technology, Taiwan 3: Department of Money and Banking, National Chengchi University, Taiwan

Publication date: 2009-02-01

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