Editor’s Letter

During the current economic crisis, bond portfolio managers are focused on fundamentals, liquidity, and systematic risk. We begin this issue of The Journal of Fixed Income with an article by Austin Murphy and Adrian Headley that empirically demonstrates that credit default swap (CDS) prices across the term spectrum can be explained by measures of inadequate liquidity to pay current liabilities, insufficient income to cover interest expenses, valuation insolvency, systematic risk, and the risk of jumps to default. Next, Hendrik Kaufmann and Philip Messow find a strong positive relationship between equity momentum and the excess returns on corporate bonds. They also provide evidence of superior investment performance from bond trading strategies based on equity momentum.

Active managers and investors at-large need to be aware of the supply-demand effects of the increasing size of index funds on its security components. In the next article, Friedrich-Carl Franz examines the corporate bond market and finds that downgrades earn statistically and economically significant abnormal returns after the announcement date. This implies a profitable trading strategy for active investors and a noted loss for passive investors as the index managers rebalance. Next, Xinjie Wang, Hongjun Yan, and Zhaodong Zhong advocate a methodology for correcting a bias in CDS spreads associated with the International Swaps and Derivatives Association CDS assumption of a constant default intensity as opposed to an empirically supported term structure of hazard rates. Their findings suggest that the bias is large, especially for CDS contracts with longer maturities.

The quality of prepayment modeling is crucial to the security selection decisions and investment performance of mortgage-backed securities traders and portfolio managers. In the next article, Jiawei Zhang argues that multidimensional rank-based error tracking creates more opportunities in specified pool and collateralized mortgage obligation markets. Finally, Lee Baker, Lihong McPhail, and Bruce Tuckman investigate the relative liquidity in the markets for US Treasury cash bonds versus futures contracts with mixed results. However, futures contracts are more useful for risk management during periods of high volatility.

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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