Fading Attention and the Pricing of Default Risk in the German Market for Structured Products

ABSTRACT

Structured retail products are unsecured bonds subject to the default risk of the issuer. We analyze the price‐setting policy of issuers with respect to this default risk. Using a long‐term data set of discount certificates in the German market, we apply a time series IVX‐approach to find that (i) quoted prices do depend on issuer default risk, but (ii) this dependency is under‐proportional. Hence, retail investors are only partially compensated for bearing issuer default risk. A long‐term analysis covering the global financial crisis, the European debt crisis, and the succeeding calm period, as well as supporting evidence from the coronavirus crisis, provides patterns consistent with a fading attention hypothesis: When default risk has left the focus of retail investors, they are no longer compensated for it, even if it becomes substantial, as in the early months of the coronavirus crisis.