Credit and liquidity components of corporate CDS spreads

This paper investigates the role of credit and liquidity factors in explaining corporate CDS price changes during normal and crisis periods. We find that liquidity risk is more important than firm-specific credit risk regardless of market conditions. Moreover, in the period prior to the recent “Great Recession” credit risk plays no role in explaining CDS price changes. The dominance of liquidity effects casts serious doubts on the relevance of CDS price changes as an indicator of default risk dynamics. Our results show how multiple liquidity factors including firm specific and aggregate liquidity proxies as well as an asymmetric information measure are critical determinants of CDS price variations. In particular, the impact of informed traders on the CDS price increases when markets are characterised by higher uncertainty, which supports concerns of insider trading during the crisis.

Price discovery of credit spreads in tranquil and crisis periods

In this paper we investigate the price discovery process in single-name credit spreads obtained from bond, credit default swap (CDS), equity and equity option prices. We analyse short term price discovery by modelling daily changes in credit spreads in the four markets with a vector autoregressive model (VAR). We also look at price discovery in the long run with a vector error correction model (VECM). We find that in the short term the option market clearly leads the other markets in the sub-prime crisis (2007-2009). During the less severe sovereign debt crisis (2009-2012) and the pre-crisis period, options are still important but CDSs become more prominent. In the long run, deviations from the equilibrium relationship with the option market still lead to adjustments in the credit spreads observed or implied from other markets. However, options no longer dominate price discovery in any of the periods considered. Our findings have implications for traders, credit risk managers and financial regulators.

Forecasting real estate returns using financial spreads

This paper examines the predictability of real estate asset returns using a number of time series techniques. A vector autoregressive model, which incorporates financial spreads, is able to improve upon the out of sample forecasting performance of univariate time series models at a short forecasting horizon. However, as the forecasting horizon increases, the explanatory power of such models is reduced, so that returns on real estate assets are best forecast using the long term mean of the series. In the case of indirect property returns, such short-term forecasts can be turned into a trading rule that can generate excess returns over a buy-and-hold strategy gross of transactions costs, although none of the trading rules developed could cover the associated transactions costs. It is therefore concluded that such forecastability is entirely consistent with stock market efficiency.

The impact of liquidity on senior credit index spreads during the subprime crisis

This paper examines the effects of liquidity during the 2007–09 crisis, focussing on the Senior Tranche of the CDX.NA.IG Index and on Moody's AAA Corporate Bond Index. It aims to understand whether the sharp increase in the credit spreads of these AAA-rated credit indices can be explained by worse credit fundamentals alone or whether it also reflects a lack of depth in the relevant markets, the scarcity of risk-capital, and the liquidity preference exhibited by investors. Using cointegration analysis and error correction models, the paper shows that during the crisis lower market and funding liquidity are important drivers of the increase in the credit spread of the AAA-rated structured product, whilst they are less significant in explaining credit spread changes for a portfolio of unstructured credit instruments. Looking at the experience of the subprime crisis, the study shows that when the conditions under which securitisation can work properly (liquidity, transparency and tradability) suddenly disappear, investors are left highly exposed to systemic risk.

Flight to quality? An investigation of changing price spreads in commercial real estate markets

Purpose – The purpose of this paper is to investigate the effect of the crisis on the pricing of asset quality attributes. This paper uses sales transaction data to examine whether flight from risk phenomena took place in the US office market during the financial crisis of 2007-2009. Design/methodology/approach – Hedonic regression procedures are used to test the hypothesis that the spread between the pricing of low-quality and high-quality characteristics increased during the crisis period compared to the pre-crisis period. Findings – The results of the hedonic regression models suggest that the price spread between Class A and other properties grew significantly during the downturn. Research limitations/implications – Our results are consistent with the hypothesis of an increased price spread following a market downturn between Class A and non-Class A offices. The evidence suggests that the relationships between the returns on Class A and non-Class A assets changed during the period of market stress or crisis. Practical implications – These findings have implications for real estate portfolio construction. If regime switches can be predicted and/or responded to rapidly, portfolios may be rebalanced. In crisis periods, portfolios might be reweighted towards Class A properties and in positive market periods, the reweighting would be towards non-Class A assets. Social implications – The global financial crisis has demonstrated that real estate markets play a crucial role in modern economies and that negative developments in these markets have the potential to spillover and create contagion for the larger economy, thereby affecting jobs, incomes and ultimately people’s livelihoods. Originality/value – This is one of the first studies that address the flight to quality phenomenon in commercial real estate markets during periods of financial crisis and market turmoil.

Understanding land-sea warming contrast in response to increasing greenhouse gases. Part I: Transient adjustment

Climate model simulations consistently show that surface temperature over land increases more rapidly than over sea in response to greenhouse gas forcing. The enhanced warming over land is not simply a transient effect caused by the land–sea contrast in heat capacities, since it is also present in equilibrium conditions. This paper elucidates the transient adjustment processes over time scales of days to weeks of the surface and tropospheric climate in response to a doubling of CO2 and to changes in sea surface temperature (SST), imposed separately and together, using ensembles of experiments with an atmospheric general circulation model. These adjustment processes can be grouped into three stages: immediate response of the troposphere and surface processes (day 1), fast adjustment of surface processes (days 2–5), and adjustment of the whole troposphere (days 6–20). Some land surface warming in response to doubled CO2 (with unchanged SSTs) occurs immediately because of increased downward longwave radiation. Increased CO2 also leads to reduced plant stomatal resistance and hence restricted evaporation, which increases land surface warming in the first day. Rapid reductions in cloud amount lead in the next few days to increased downward shortwave radiation and further warming, which spreads upward from the surface, and by day 5 the surface and tropospheric response is statistically consistent with the equilibrium value. Land surface warming in response to imposed SST change (with unchanged CO2) is slower. Tropospheric warming is advected inland from the sea, and over land it occurs at all levels together rather than spreading upward from the surface. The atmospheric response to prescribed SST change in about 20 days is statistically consistent with the equilibrium value, and the warming is largest in the upper troposphere over both land and sea. The land surface warming involves reduction of cloud cover and increased downward shortwave radiation, as in the experiment with CO2 change, but in this case it is due to the restriction of moisture supply to the land (indicated by reduced soil moisture), whereas in the CO2 forcing experiment it is due to restricted evaporation despite increased moisture supply (indicated by increased soil moisture). The warming over land in response to SST change is greater than over the sea and is the dominant contribution to the land–sea warming contrast under enhanced CO2 forcing.

Cross-hemispheric transport of Central African biomass burning pollutants: Implications for downwind ozone production

Pollutant plumes with enhanced concentrations of trace gases and aerosols were observed over the southern coast of West Africa during August 2006 as part of the AMMA wet season field campaign. Plumes were observed both in the mid and upper troposphere. In this study we examined the origin of these pollutant plumes, and their potential to photochemically produce ozone (O3) downwind over the Atlantic Ocean. Their possible contribution to the Atlantic O3 maximum is also discussed. Runs using the BOLAM mesoscale model including biomass burning carbon monoxide (CO) tracers were used to confirm an origin from central African biomass burning fires. The plumes measured in the mid troposphere (MT) had significantly higher pollutant concentrations over West Africa compared to the upper tropospheric (UT) plume. The mesoscale model reproduces these differences and the two different pathways for the plumes at different altitudes: transport to the north-east of the fire region, moist convective uplift and transport to West Africa for the upper tropospheric plume versus north-west transport over the Gulf of Guinea for the mid-tropospheric plume. Lower concentrations in the upper troposphere are mainly due to enhanced mixing during upward transport. Model simulations suggest that MT and UT plumes are 16 and 14 days old respectively when measured over West Africa. The ratio of tracer concentrations at 600 hPa and 250 hPa was estimated for 14–15 August in the region of the observed plumes and compares well with the same ratio derived from observed carbon dioxide (CO2) enhancements in both plumes. It is estimated that, for the period 1–15 August, the ratio of Biomass Burning (BB) tracer concentration transported in the UT to the ones transported in the MT is 0.6 over West Africa and the equatorial South Atlantic. Runs using a photochemical trajectory model, CiTTyCAT, initialized with the observations, were used to estimate in-situ net photochemical O3 production rates in these plumes during transport downwind of West Africa. The mid-troposphere plume spreads over altitude between 1.5 and 6 km over the Atlantic Ocean. Even though the plume was old, it was still very photochemically active (mean net O3 production rates over 10 days of 2.6 ppbv/day and up to 7 ppbv/day during the first days) above 3 km especially during the first few days of transport westward. It is also shown that the impact of high aerosol loads in the MT plume on photolysis rates serves to delay the peak in modelled O3 concentrations. These results suggest that a significant fraction of enhanced O3 in mid-troposphere over the Atlantic comes from BB sources during the summer monsoon period. According to simulated occurrence of such transport, BB may be the main source for O3 enhancement in the equatorial south Atlantic MT, at least in August 2006. The upper tropospheric plume was also still photochemically active, although mean net O3 production rates were slower (1.3 ppbv/day). The results suggest that, whilst the transport of BB pollutants to the UT is variable (as shown by the mesoscale model simulations), pollution from biomass burning can make an important contribution to additional photochemical production of O3 in addition to other important sources such as nitrogen oxides (NOx) from lightning.

LIPGENE food-exchange model for alteration of dietary fat quantity and quality in free-living participants from eight European countries

Controlled human intervention trials are required to confirm the hypothesis that dietary fat quality may influence insulin action. The aim was to develop a food-exchange model, suitable for use in free-living volunteers, to investigate the effects of four experimental diets distinct in fat quantity and quality: high SFA (HSFA); high MUFA (HMUFA) and two low-fat (LF) diets, one supplemented with 1.24g EPA and DHA/d (LFn-3). A theoretical food-exchange model was developed. The average quantity of exchangeable fat was calculated as the sum of fat provided by added fats (spreads and oils), milk, cheese, biscuits, cakes, buns and pastries using data from the National Diet and Nutrition Survey of UK adults. Most of the exchangeable fat was replaced by specifically designed study foods. Also critical to the model was the use of carbohydrate exchanges to ensure the diets were isoenergetic. Volunteers from eight centres across Europe completed the dietary intervention. Results indicated that compositional targets were largely achieved with significant differences in fat quantity between the high-fat diets (39.9 (SEM 0.6) and 38.9 (SEM 0.51) percentage energy (%E) from fat for the HSFA and HMUFA diets respectively) and the low-fat diets (29.6 (SEM 0.6) and 29.1 (SEM 0.5) %E from fat for the LF and LFn-3 diets respectively) and fat quality (17.5 (SEM 0.3) and 10.4 (SEM 0.2) %E front SFA and 12.7 (SEM 0.3) and 18.7 (SEM 0.4) %E MUFA for the HSFA and HMUFA diets respectively). In conclusion, a robust, flexible food-exchange model was developed and implemented successfully in the LIPGENE dietary intervention trial.

Increased n-6 polyunsaturated fatty acids do not attenuate the effects of long-chain n-3 polyunsaturated fatty acids on insulin sensitivity or triacylglycerol reduction in Indian Asians

Background: Indian Asians in Western countries have a higher rate of coronary artery disease than do the indigenous white populations, and this higher rate may be influenced by a dietary imbalance of n-6 and n-3 polyunsaturated fatty acids (PUFAs). Objective: The objective of the study was to test the hypothesis that a high background dietary intake of n-6 PUFA attenuates the effects of fish-oil supplementation on insulin sensitivity and associated blood lipids of the metabolic syndrome. Design: Twenty-nine Indian Asian men were recruited to participate in a 12-wk dietary intervention trial. Volunteers were randomly assigned to receive either a moderate or a high n-6 PUFA diet featuring modified oils and spreads over a 6-wk period. After this 6-wk period, both groups were supplemented with 4.0 g fish oil/d (2.5 g eicosapentaenoic acid + docosahexaenoic acid) for an additional 6 wk in combination with the dietary treatment. Volunteers participated in a postprandial study and an insulin sensitivity test after the 6-wk dietary intervention and again after the fish-oil supplementation period. Results: There was no significant time X treatment interaction for blood lipids or insulin action after dietary intervention with the moderate or high n-6 PUFA diets in combination with fish oil. After the 6-wk period of fish oil supplementation, fasting and postprandial plasma triacylglycerol concentrations decreased significantly. Conclusion: The background dietary n-6 PUFA concentration did not modulate the effect of fish-oil supplementation on blood lipids or measures of insulin sensitivity in this ethnic group.

Pricing inefficiencies in private real estate markets using total return swaps

Efficient markets should guarantee the existence of zero spreads for total return swaps. However, real estate markets have recorded values that are significantly different from zero in both directions. Possible explanations might suggest non-rational behaviour by inexperienced market players or unusual features of the underlying asset market. We find that institutional characteristics in the underlying market lead to market inefficiencies and, hence, to the creation of a rational trading window with upper and lower bounds within which transactions do not offer arbitrage opportunities. Given the existence of this rational trading window, we also argue that the observed spreads can substantially be explained by trading imbalances due to the limited liquidity of a newly formed market and/or to the effect of market sentiment, complementing explanations based on the lag between underlying market returns and index returns.

Cholesterol reduction using manufactured foods high in monounsaturated fatty acids: a randomized crossover study

In two separate studies, the cholesterol-lowering efficacy of a diet high in monounsaturated fatty acids (MUFA) was evaluated by means of a randomized crossover trial. In both studies subjects were randomized to receive either a high-MUFA diet or the control diet first, which they followed for a period of 8 weeks; following a washout period of 4–6 weeks they were transferred onto the opposing diet for a further period of 8 weeks. In one study subjects were healthy middle-aged men (n 30), and in the other they were young men (n 23) with a family history of CHD recruited from two centres (Guildford and Dublin). The two studies were conducted over the same time period using identical foods and study designs. Subjects consumed 38% energy as fat, with 18% energy as MUFA and 10% as saturated fatty acids (MUFA diet), or 13% energy as MUFA and 16% as saturated fatty acids (control diet). The polyunsaturated fatty acid content of each diet was 7%. The diets were achieved by providing subjects with manufactured foods such as spreads, ‘ready meals’, biscuits, puddings and breads, which, apart from their fatty acid compositions, were identical for both diets. Subjects were blind to which of the diets they were following on both arms of the study. Weight changes on the diets were less than 1 kg. In the groups combined (n 53) mean total and LDL-cholesterol levels were significantly lower at the end of the MUFA diet than the control diet by 0×29 (SD 0×61) mmol/l (P,0×001) and 0×38 (SD 0×64) mmol/l (P, 0×0001) respectively. In middle-aged men these differences were due to a mean reduction in LDL-cholesterol of ¹11 (SD 12) % on the MUFA diet with no change on the control diet (¹1×1 (SD 10) %). In young men the differences were due to an increase in LDL-cholesterol concentration on the control diet of þ6×2 (SD 13) % and a decrease on the MUFA diet of ¹7×8 (SD 20) %. Differences in the responses of middle-aged and young men to the two diets did not appear to be due to differences in their habitual baseline diets which were generally similar, but appeared to reflect the lower baseline cholesterol concentrations in the younger men. There was a moderately strong and statistically significant inverse correlation between the change in LDLcholesterol concentration on each diet and the baseline fasting LDL-cholesterol concentration (r¹0×49; P,0×0005). In conclusion, diets in which saturated fat is partially replaced by MUFA can achieve significant reductions in total and LDL-cholesterol concentrations, even when total fat and energy intakes are maintained. The dietary approach used to alter fatty acid intakes would be appropriate for achieving reductions in saturated fat intakes in whole populations.

Substitution of dietary monounsaturated fatty acids for saturated fatty acids in a free-living population: a feasibility study

The fatty acid composition of the diet of seven free-living subjects (five men and two women) aged 41–56 years was altered for 1 month. The aim was to increase the intake of monounsaturated fatty acids (MUFAs) from subjects current habitual levels of 12% dietary energy to a target intake of 18% dietary energy, and to decrease saturated fatty acid (SFA) from habitual levels of 16% dietary energy to target levels of 10% dietary energy. The change in fatty acid intake was achieved by supplying volunteers with foods prepared using MUFA-containing spreads or olive oil (ready meals, sweet biscuits and cakes) and also by supplying spreads, cooking oil and MUFA-enriched milk for domestic use. Body weight and plasma total cholesterol measurements were made at baseline and at 2 and 4 weeks on the diet as an aid to maintaining subject compliance. MUFA consumption was significantly increased from 12% dietary energy to 16% dietary energy (P<0.01), and SFA intake was reduced from 16% dietary energy to 6% dietary energy (P<0.01) during the 4-week intervention. The diet failed to achieve the target increase in MUFA but exceeded the target reduction in SFA. This was due to the fact that subjects reduced their total fat intake from a mean habitual level of 38% dietary energy to a mean level of 30% dietary energy. During the dietary period, mean plasma cholesterol levels were lower at 2 weeks (P<0.01) and at 4 weeks (P<0.01) than the baseline, with a mean reduction of 20% over the dietary period. This study demonstrates the difficulty of achieving increased MUFA intakes (by SFA substitution) in free-living populations when only a limited range of fatty-acid modified food products are provided to volunteers.

Detecting intraday periodicities with application to high frequency exchange rates

Many recent papers have documented periodicities in returns, return volatility, bid–ask spreads and trading volume, in both equity and foreign exchange markets. We propose and employ a new test for detecting subtle periodicities in time series data based on a signal coherence function. The technique is applied to a set of seven half-hourly exchange rate series. Overall, we find the signal coherence to be maximal at the 8-h and 12-h frequencies. Retaining only the most coherent frequencies for each series, we implement a trading rule that is based on these observed periodicities. Our results demonstrate in all cases except one that, in gross terms, the rules can generate returns that are considerably greater than those of a buy-and-hold strategy, although they cannot retain their profitability net of transactions costs. We conjecture that this methodology could constitute an important tool for financial market researchers which will enable them to detect, quantify and rank the various periodic components in financial data better.

Back from beyond the bid-ask spread: perspectives on liquidity

Research into the topic of liquidity has greatly benefited from the availability of data. Although bid-ask spreads were inaccessible to researchers, Roll (1984) provided a conceptual model that estimated the effective bid-ask prices from regular time series data, recorded on a daily or longer interval. Later data availability improved and researchers were able to address questions regarding the factors that influenced the spreads and the relationship between spreads and risk, return and liquidity. More recently transaction data have been used to measure the effective spread and researchers have been able to refine the concepts of liquidity to include the impact of transactions on price movements (Clayton and McKinnon, 2000) on a trade-by-trade analysis. This paper aims to use techniques that combine elements from all three approaches and, by studying US data over a relatively long time period, to throw light on earlier research as well as to reveal the changes in liquidity over the period controlling for extraneous factors such as market, age and size of REIT. It also reveals some comparable results for the UK market over the same period.