In this section we will present the independent variables used in the study. Al-though we use two dierent markets for the spread variables we are still going to use Norwegian macro factors as this is the relevant source of risk also for the EUR bonds. Most of the variables are common in both studies as we will indicate further on.
Data is for the most part retrieved from Bloomberg. Bid-ask yield spreads are based on the Bloomberg Generic prices (BGN) methodology. They are single-security composites derived from dealer contribution. Indicative and executable prices are considered and weighed according to prespecied criteria. These prices are indicative of available consensus-forming prices (Bloomberg, 2016). We believe that this combination of executable and reliable indicative prices provides the best picture of market prices for the bonds under study.
In the following we present both macroeconomic and bond-specic variables with their expected eect on spreads in both samples.
6.2.1 Macroeconomic factors Risk-free interest rate
As mentioned in Section 2, according to Longsta and Schwartz (1995) bond spreads should react negatively to increased risk-free interest rates due to the lower risk-neutral probability of default. Furthermore, since interest rates are proven to be non-stationary in low-interest rate environments we dierence the proxies for the short-term risk-free interest rates, i.e. month Euribor and 3-month Nibor and expect the spreads to react negatively in both samples.
Term spread
We include the term spread (slope of the term structure) calculated as the dier-ence between the 10-year and the 3-month Nibor rate. This has been shown to be an important indicator of the economy, especially a predictor of economic reces-sions (Prokopczuk & Vonho, 2012; Bernard & Gerlach, 1998). As an increased slope (steeper term structure) normally corresponds with a more healthy eco-nomic outlook (and hence lower uncertainty for bond investors) we would expect a negative relation between spreads and the slope factor in both samples.
Equity returns
The return on a country's major stock index is associated with the general health of the economy and the business climate which should be negatively related to spreads (Prokopczuk & Vonho, 2012). Hence we include the returns on the Oslo Stock Exchange (OSE) benchmark index. We use the 4 weeks rolling returns to reduce the impact of noise and expect a negative relation between spreads and equity returns in both samples due to the increased positivity in the market.
Implied volatility
In line with the previous, we would also expect that increased (expected) volatility in the equity factor to be relevant, however with the opposite sign as greater uncertainty should translate into a higher compensation to holding risky assets.
We use the 30-day OSE implied volatility index6 and expect a positive relation between spreads and implied volatility in both samples.
Real estate returns
Recalling that all Norwegian covered bonds are backed by cover pools which largely constitute Norwegian housing mortgages we include real estate returns to
6Because put and call options on the issuers are non-existent it is not possible to back out implied volatility for issuers using the Black-Scholes option pricing formula. Instead we use the 30-day implied volatility on Oslo Stock Exchange to get a forward looking estimate of market volatility.
proxy for the average cover pool quality. We expect a negative relation between real estate returns and covered bond spreads in both samples as lower returns reduce the exibility of cover pools and hence lower the collateral. We note that Norwegian housing statistics are only quoted on a monthly basis which cause this variable to change slower than the rest of the dataset.
Cross-currency basis swap
As cross-currency basis swaps are commonly used to hedge conversion of foreign funding back to domestic currency, the CCBS is an important factor in the rela-tive funding costs between domestic and foreign currency. This should in theory equal the dierence in yields on else equal bonds denominated in EUR and NOK.
Increases in the cross-currency basis swap should increase the observed spreads as EUR issues become relatively cheaper for both issuers and potential bond in-vestors. We include the 5-year EURNOK cross-currency basis swap.
6.2.2 Bond-specic factors
In addition to the macroeconomic factors that are equal for all the bonds in our samples we include bond-specic factors justied in theory.
Taxes
In their study, Prokopczuk and Vonho (2012) include the coupon rate to account for tax-eects as bonds that pay higher during the early part of the lifetime are more taxed and hence should reward additional spreads. As this eect is negligible for FRNs due to the continuous resetting we include only the coupon payments for the EUR sample and expect a positive relation.
Liquidity
In line with most previous studies (Prokopczuk & Vonho, 2012; Kempf et al., 2012; Koziol & Sauerbier, 2007) etc. that largely point out liquidity as the most important factor we expect that it should also be important in our sample. In the EUR sample we use the relative bid-ask yield spread and expect that larger
bid-ask spreads should translate to lower liquidity and hence wider bond spreads.
As the Norwegian sample suers from less frequent trading (often with close-to-constant or erroneous bid-ask spreads) we use the number of trades reported from OSE on a monthly basis as our proxy for liquidity and expect that a higher number of trades corresponds with reduced bond spreads (Houweling, Mentink,
& Vorst, 2005). We note that this variable is updated less frequently than others like in the case with real estate returns.
Issuer-specic eects
Although the regulations and requirements around covered bonds are strong we expect issuer-specic eects to be relevant. We hypothesize that DNB, Norway's largest mortgage bank and the bank with most international exposure7 should trade at slightly lower spreads in both samples. This might e.g. be due to the larger cover pool, reporting standards and general solidity. We therefore include issuer-specic dummies and measure their impact on spreads relative to DNB.
Time to maturity
At last we include the bond's time to maturity (measured in years until maturity) to control for the fact that bonds with higher time to maturity are less liquid, more risky (longer duration) and generally trade at higher spreads.