Sovereign-Bond Backed Securities as a new Safe Asset for the Eurozone: a Dynamic Credit Risk Perspective

We carry out a detailed quantitative analysis for synthetic securities backed by diversified portfolios of European sovereign bonds (socalled SBSs). Such securities have recently received a lot of interest as a tool to... [ view full abstract ]

We carry out a detailed quantitative analysis for synthetic securities backed by diversified portfolios of European sovereign bonds (socalled SBSs). Such securities have recently received a lot of interest as a tool to improving the functioning of the euro area. For this we popose a  reduced-form credit risk model with common Markov modulated mean-reversion level that  captures the co-movement of credit spreads. We carry out an empirical analysis of this model and derive analytical pricing formulas. Moreover, we study the robustness of SBSs and the impact of defaults and regime switches on the volatility of SBSs.