A longer term debt–equity cycle
Credit spreads historically have been negatively correlated with 3-year rolling equity-market returns, as we would have expected from the Merton model. Indeed, there seems to be a longer term debt–equity cycle. But the chart also reveals a significant decoupling of equity and credit during the 1990s. Since equity-market performance alone is only temporarily able to explain variations of credit spreads, we will now analyze the impact of equity volatility on spreads. However, most of the time equity prices and implied volatility tell the same story. When stock prices are falling, demand for protection increases, and thus volatility, which is simply the price of protection, rises. The result is a strong negative correlation between equity prices and option-implied volatility. Yet the times, when both markets tell different stories, are the most interesting.
Tags: market cycles, money, Partnership, payment, price, Private Annuities, property, purchase real estate, shares, tax