Currently, the spread of collateralized AAA bonds, which are seen as almost risk free, is about 70-100 bp above the euro swap rate (see Iboxx or UBS delta).Some see this whole spread as a liquidity premium.Does anyone has a view on whether this is indeed a liquidity premium?Or could it be reluctance of investors to invest in a product involving banks, mortgages and a complex structure? Or does the market doesn't see this as risk free at the moment?

Most likely a combination of factors, but difficult to say without knowing more about the security in question. I would say it is both taking the risk of credit losses (i.e. there is some systemic credit risk priced in) together with a liquidity premium required to sell a complex, illiquid asset in current market conditions.Some typical questions to ask yourself:What is the collateral? What is the price volatility of the underlying collateral.Are the bonds guaranteed or over-collateralised? -If guaranteed, what is the credit quality of the guarantor. -If over collateralised, by how much? Not much, but hope it helps.

Whats the quality and reliability of rating?

It are covered bonds, like German Pfandbriefe. Most of the collateral are mortgages and it's generally over-collateralized with about 10%.

Is this really a surprise in the market where you can get paid several hundred bps on a basis package?

QuoteOriginally posted by: ChurchCurrently, the spread of collateralized AAA bonds, which are seen as almost risk free, is about 70-100 bp above the euro swap rate (see Iboxx or UBS delta).Some see this whole spread as a liquidity premium.Does anyone has a view on whether this is indeed a liquidity premium?Or could it be reluctance of investors to invest in a product involving banks, mortgages and a complex structure? Or does the market doesn't see this as risk free at the moment?Supply exceeds demand... This is the only way I think of these things nowadays. Dislocations similar to this appeared in various mkts ever since the DEPFA/Hypo Re debacle. Nothing to be particularly shocked about any more...

QuoteOriginally posted by: ChurchCurrently, the spread of collateralized AAA bonds, which are seen as almost risk free, is about 70-100 bp above the euro swap rate (see Iboxx or UBS delta).Some see this whole spread as a liquidity premium.Does anyone has a view on whether this is indeed a liquidity premium?Or could it be reluctance of investors to invest in a product involving banks, mortgages and a complex structure? Or does the market doesn't see this as risk free at the moment?Check out S&P's request for comments on changes to rating methodology for covered bonds (2009-02-04). According to the proposed changes 60 % of European CB's are facing downgrades. Perhaps the spreads do not look that wide now hehe? Interestingly spanish cedulas may be the least affected by these changes since the cover pool can live on even when the issuing bank is insolvent with basically no impairment to the assets of the pool (and possible some UK pass-through structures). On the other hand nordic bonds may be hit hard if the changes are implemented. Even though the CB market is quite dull this may be a very interesting phase since the fact that there is just talk about downgrading such a vast amount of bonds that are dependent on the AAA rating would send ripples through the market. Have seen any yet though... Comments?