K. Dullmann et M. Windfuhr, Credit spreads between German and Italian sovereign bonds: Do one-factor affine models work?, CAN J ADM S, 17(2), 2000, pp. 166-181
Citations number
28
Categorie Soggetti
Management
Journal title
CANADIAN JOURNAL OF ADMINISTRATIVE SCIENCES-REVUE CANADIENNE DES SCIENCES DE L ADMINISTRATION
In this paper we analyze the credit spread between Italian and German gover
nment bonds after the exchange-rate agreement in May 1998. We estimate the
parameters of two mean-reverting affine models for the German term structur
e and the spread process-the Gaussian Vasicek and the square-root Cox-Inger
soll-Ross (CIR) model. Similar to Pearson and Sun (1994) we combine cross-s
ectional and rime-series information of daily observations to estimate the
process parameters employing a maximum likelihood method. Our empirical res
ults show that the Vasicek and CIR model describe the German term structure
dynamics equally well. Both models fail to account for all observed shapes
of the credit spread structure whereas the spread residuals in the Vasicek
case seem to be less volatile. Our results suggest application in the area
of pricing credit-sensitive instruments such as credit derivatives or the
management of credit risk, especially for European government debt.