Implied Equity and Firm Asset Volatility in Credit Default Swap Premia

Abstract

We investigate the informational content of credit default swap (CDS) spreads for future volatility of (firm) assets and equity. In the cross-section, CDS spreads are significantly more informative about future asset than equity volatility. The informational content of historical and option implied volatilities is generally lower than that of CDS implied volatilities but exhibits the same pattern. We argue both theoretically and empirically that this common pattern reflects a fundamental difference in the cross-sectional predictability of asset and equity volatility. This difference lies in the leverage effect component in equity volatility, and the interconnection between leverage and asset volatility.