I am trying to plot the asset swap spreads of government inflation-linked bonds (ILBs) versus the asset swap spread of government nominal (plain-vanilla) reference bonds.
I used the article in the link below:
a.) I have conceptual concerns using the net-proceeds asset swap structure (let me qualify that that by saying, given my understandings). My understanding is that we are trying to solve for the asset swap spread (which is built into the floating leg of the asset swap) which sets:
where Fixed denotes the fixed leg of the swap and Floating the floating leg of the swap. I felt more comfortable with the par asset swap structure - solving for the asset swap spread which sets:
where AIP is the current bond all-in-price. Why I liked this was because if a bond was issued with a high coupon rate (relative to current interest rate environment) but had an all-in-price less than par (100), one would conclude the bond had poorer credit quality (relatively speaking - and just assume there is no liquidity premium, etc.) This was then matched by a larger asset swap spread - ie. as holder of the bond I am compensated more for its inferior credit quality.
But I don't see this mechanism in the net-proceeds asset swap because the all-in-price is not built into the structure (in the par asset swap structure, at initiation you pay par for a bond whose current value is the all in price, while under the net-proceeds structure, you pay the all-in-price (so that (AIP-100) term is not present in the net-proceeds structure as it is in the par-asset swap structure)
b.) Anyway having used the net-proceeds for the ILBs, the graph of the ILB asset swap spread is completely different to the Nominal asset swap spread - the ILB spreads are roughly around double the size of Nominal spreads and the shape of the graph (vs. maturity of the bonds) is erratic and wholly different to the shape of the Nominal curve
Now this may be due to the different credit risk profile of the ILB versus a plain vanilla nominal bond (explained in the article in the link above). But the article fails to cover how to account/compensate for this differing credit structure (so that we could compare the ILB spreads to its reference nominal bond's spread). How would one account for this?
Does anyone have an idea how one should go about this? or more generally to model the asset swap spread for ILBs?
Any help is greatly appreciated