Editor’s Letter

How much do investors rely on credit ratings? In this issue of The Journal of Fixed Income, we begin with an article by Frank Fabozzi and Dennis Vink that provides empirical evidence that investors use additional credit factors beyond agency ratings in pricing new issues of risky residential mortgage-backed security tranches.

Government programs have not been successful at restoring a well-functioning mortgage market. The equilibrium that needs to be reached is that many previous credit-impaired homeowners will become renters and some qualified renters will become homeowners. But the inventory difference can be made up from demand by investors. In the next article, Laurie Goodman, Roger Ashworth, Brian Landy, and Lidan Yang analyze the supply versus demand imbalance in the residential mortgage market and make a strong case for a new asset class: investor-owned homes for rent. Hence, they advocate policies to make financing for investor-owned properties more available as a way to increase the demand for housing.

There is much to study about credit risk during the recent financial crisis. Alex YiHou Huang, Chung-Hua Shen, and Chih-Chun Chen find that credit default swap (CDS) spreads of financials jump prior to the occurrence of major events. Furthermore, they analyze the contagion across industries. In the next article, Riccardo Pianeti, Rosella Giacometti, and Valentina Acerbis consider the risk of simultaneous default of multiple institutions (systemic risk). They provide a model to extract the forward-looking joint default probabilities of financial institutions from CDS market data.

Another relevant dimension of a financial crisis is a lack of liquidity. In the next article, Ren-Raw Chen models this liquidity discount as a put option. The cause of the discount is the supply of a risky asset growing faster than demand.

The price behavior of fallen angels is important to the performance of fixed income portfolios. Brent Ambrose, Kelly Cai, and Jean Helwege provide evidence that bond returns after a downgrade event are a result of information effects and not from the price pressure associated with forced sales.

We hope you enjoy this issue of The Journal of Fixed Income. Your continued support of the journal is greatly appreciated.

Stanley J. Kon

Editor

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