Application of the Fama and French Factor Models to the Credit Default Swaps (CDS) Market

Abstract

In this paper we apply the Fama French (FF) three-factor (3F) and five-factor (5F) models to the CDS market. By converting daily CDS spreads into daily returns we are able to perform tests on the FF 3F and 5F models. Our results provide evidence that both 3F and 5F models can be extended to the CDS market. We also test the default risk hypothesis, by augmenting the FF models with the distance-to-default factor. Our findings suggest it is unlikely that SMB and HML are proxying for the default risk. We conclude that the FF 5F model is the preferred model for explaining daily CDS returns.