Federal Deposit InsuranceCorporation• Center for Financial Researchh
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2005-11
Correlation, Price Discovery and Co-movement of ABS and Equity
State-
Andreas A. Jobst
June 20 July 2005
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2005-11
Correlation, Price Discovery and Co-movement of ABS and Equity
State-
Andreas A. Jobst
June 20 July 2005
1
Correlation, Price Discovery and Co-movement of ABS and Equity
forthcoming in Derivatives Use, Trading & Regulation (2005, Vol. 11, No. 3)
by
Andreas A. Jobst#
July 2005
FDIC Center for Financial Research Working Paper No. 2005-11
Abstract
Asset-backed securitization (ABS) has become a viable and increasingly attractive risk
management and refinancing method either as a standalone form of stru ctured finance or as
securitized debt in Collateralized Debt Obligations (CDO). However, the absence of industry
standardization has prevented rising investment demand from translating into market liquidity
comparable to traditional fixed income instruments, in all but a few selected market segments.
Particularly low financial transparency and comp lex security designs inhibit profound analysis
of secondary market pricing and how it relates to established forms of external finance. This
paper represents the first attempt to measure th e intertemporal, bivariate causal relationship
between matched price series of equity and ABS issued by the same entity. In a two-
dimensional linear system of simultaneous equa tions we investigate the short-term dynamics
and long-term consistency of daily secondary market data from the U.K. Sterling ABS/MBS
market and exchange traded shares between 1998 and 2004 with and without the presence of
cointegration. Our causality framework delivers compelling empirical support for a strong co-
movement between matched price series of AB S-equity pairs, where ABS markets seem to
contribute more to price discovery over the long run. Controlling for cointegration, risk-free
interest and average market risk of corporate de bt hardly alters our results. However, once we
qualify the magnitude and direction of price discovery on various security characteristics, such
as the ABS asset class, we find that ABS-equi ty pairs with large-scal e CMBS/RMBS and credit
card/student loan ABS reveal stronger lead-lag relationships and joint price dynamics than
whole business ABS.
Keywords: co-movement, causality test, vector autoregression (VAR), vector error correction
mechanism (VECM), short-term price dynamics, price discovery, asset-backed securities (ABS),
securitization, mortgage-backed securities (MBS), collateralized debt obligation (CDO), captive
finance, Pfandbrief, cointegration
# International Monetary Fund (IMF), International Capital Markets Department (ICM), 700 19 th Street,
NW, Washington, D.C. 20431; Visiting Fellow, Federal Deposit Insurance Corporation (FDIC), Center
for Financial Research (CFR), 550 17th Street NW, Washington, DC 20429, USA; E-mail:
ajobst@imf.org. The paper represents the views and analysis of the author and does not represent those
of the IMF or the FDIC. Any errors and omissions are the sole responsibility of the author.
Correlation, Price Discovery and Co-movement of ABS and Equity
forthcoming in Derivatives Use, Trading & Regulation (2005, Vol. 11, No. 3)
by
Andreas A. Jobst#
July 2005
FDIC Center for Financial Research Working Paper No. 2005-11
Abstract
Asset-backed securitization (ABS) has become a viable and increasingly attractive risk
management and refinancing method either as a standalone form of stru ctured finance or as
securitized debt in Collateralized Debt Obligations (CDO). However, the absence of industry
standardization has prevented rising investment demand from translating into market liquidity
comparable to traditional fixed income instruments, in all but a few selected market segments.
Particularly low financial transparency and comp lex security designs inhibit profound analysis
of secondary market pricing and how it relates to established forms of external finance. This
paper represents the first attempt to measure th e intertemporal, bivariate causal relationship
between matched price series of equity and ABS issued by the same entity. In a two-
dimensional linear system of simultaneous equa tions we investigate the short-term dynamics
and long-term consistency of daily secondary market data from the U.K. Sterling ABS/MBS
market and exchange traded shares between 1998 and 2004 with and without the presence of
cointegration. Our causality framework delivers compelling empirical support for a strong co-
movement between matched price series of AB S-equity pairs, where ABS markets seem to
contribute more to price discovery over the long run. Controlling for cointegration, risk-free
interest and average market risk of corporate de bt hardly alters our results. However, once we
qualify the magnitude and direction of price discovery on various security characteristics, such
as the ABS asset class, we find that ABS-equi ty pairs with large-scal e CMBS/RMBS and credit
card/student loan ABS reveal stronger lead-lag relationships and joint price dynamics than
whole business ABS.
Keywords: co-movement, causality test, vector autoregression (VAR), vector error correction
mechanism (VECM), short-term price dynamics, price discovery, asset-backed securities (ABS),
securitization, mortgage-backed securities (MBS), collateralized debt obligation (CDO), captive
finance, Pfandbrief, cointegration
# International Monetary Fund (IMF), International Capital Markets Department (ICM), 700 19 th Street,
NW, Washington, D.C. 20431; Visiting Fellow, Federal Deposit Insurance Corporation (FDIC), Center
for Financial Research (CFR), 550 17th Street NW, Washington, DC 20429, USA; E-mail:
ajobst@imf.org. The paper represents the views and analysis of the author and does not represent those
of the IMF or the FDIC. Any errors and omissions are the sole responsibility of the author.