Credit Default Swap Prices Research Articles

The Information in Credit Default Swap Volume

This article examines the informational content of credit default swap (CDS) net notional for future stock and CDS prices. Using the information on CDS contracts registered in DTCC, a clearinghouse, I construct CDS-to-debt ratios from net notional, that is, the sum of net positive positions of all market participants, and total outstanding debt issued by the reference entity. Unlike the ratio using the sum of all outstanding CDS contracts, this ratio directly indicates how much of debt is insured with CDS and therefore, is a natural measure of investors’ concern on a credit event of the reference entity. Empirically, I find crosssectional evidence that the current increase in CDS-to-debt ratios can predict a decrease in stock prices and an increase in CDS premia of the reference firms in the next week. Greater predictability for firms with investment grade credit ratings or low CDS-to-debt ratios suggests that investors pay more attention to firms in good credit conditions than those regarded as junk or already insured considerably with CDS.

Pricing Credit Default Swaps Under Multifactor Reduced-Form Models: A Differential Quadrature Approach

We present a new numerical method for pricing credit default swaps under fully correlated multifactor reduced-form models. In particular, the proposed approach combines an implicit/explicit operator splitting procedure with the harmonic differential quadrature scheme, and is so efficient that it can be applied to models with up to six stochastic factors. This is a remarkable advantage, as we can use two factors to describe the interest rate, other two factors to describe the default probability, and other two factors to take into account, for example, the so-called counterparty risk. The performances of the novel method are demonstrated by extensive simulation, in which various kinds of models with four and six fully correlated factors are considered.

The Determinants of CDS Spreads: Evidence from the Model Space

We apply Bayesian Model Averaging and a frequentistic model space analysis to assess the pricing determinants of credit default swaps (CDS). Our study focuses on the complete model space of plausible models and thus supports ultimate transparency and robustness. Using a large dataset of CDS contracts we find that CDS price dynamics can be mainly explained by factors describing firms' sensitivity to extreme market movements. More precisely, our results suggest that dynamic copula based measures of tail dependence incorporate most essential pricing information, making other potential determinants such as Merton-type factors or linear variables measuring the systematic market evolution negligible. This is in line with intermediary asset pricing theory.

Beating Market Expectations, Analysts’ Forecasts Dispersion and the Pricing of Credit Default Swaps

The purpose of this paper is to study the impact of beating analysts’ forecasts and the impact of analysts’ forecast dispersion on the pricing of firms’ credit default swaps (CDSs). CDS premium is the compensation required by investors for bearing firms’ credit default risk. Sell-side analysts collect market, industry and firm information and provide important information in the form of stock recommendations, stock price targets and accounting number forecasts. For that reason, the information contained in their forecasts may provide additional information to investors to price CDSs. My results show that firms that beat analysts’ earnings and revenue forecasts, and firms with less dispersed analysts’ earnings and revenue forecasts have on average a reduction in their CDS premia around the earnings announcement date. These effects are stronger for firm that jointly beat the two forecasts and for firms with high risk of default. I also document that the effect of beating analysts’ earnings (revenue) forecasts is stronger for firms with more (less) earnings quality.

Computing the survival probability in the Madan–Unal credit risk model: application to the CDS market

We obtain a quasi-analytical approximation of the survival probability in the credit risk model proposed in [Madan, D.B. and Unal, H., Pricing the risk of default. Rev. Deriv. Res., 1998, 2(2), 121–160]. Such a formula, which extensive numerical simulations reveal to be accurate and computationally fast, can also be employed for pricing credit default swaps (CDSs). Specifically, we derive a quasi-analytical approximate expression for CDS par spreads, and we use it to estimate the parameters of the model. The results obtained show a rather satisfactory agreement between theoretical and real market data.

Ambiguity, Volatility, and Credit Risk

We explore the implications of ambiguity, or Knightian uncertainty, for the pricing of credit default swaps (CDS). We find that ambiguity, as opposed to risk, has a negative impact on spreads, and its economic significance is as important as that of risk. A one standard deviation increase in the level of ambiguity is associated with a decrease in spreads of at least six percent. Our analysis provides broader insights for the impact of ambiguity on the pricing of other classes of insurance claims and equity options.

Boarding a Sinking Ship? An Investigation of Job Applications to Distressed Firms

ABSTRACTWe use novel data from a leading online job search platform to examine the impact of corporate distress on firms’ ability to attract job applicants. Survey responses suggest that job seekers accurately perceive firms’ financial condition, as measured by companies’ credit default swap prices and accounting data. Analyzing responses to job postings by major financial firms during the Great Recession, we find that an increase in an employer's distress results in fewer and lower quality applicants. These effects are particularly evident when the social safety net provides workers with weak protection against unemployment and for positions requiring a college education.

Liquidity and Pricing of Credit Default Swaps in Japan: Evidence from a Benchmark Index for Corporate Debt Claims

This article is a contribution towards the growing empirical literature on the relationship between liquidity and pricing of credit default swaps (CDSs). To the best of my knowledge, the article becomes the first to show that market liquidity does matter to CDS pricing in Japan, by looking into a sole benchmark index of CDS trading for investment-grade debt claims, or the Markit iTraxx Japan (MiJ). The impact of illiquidity on MiJ premia has declined since the International Swaps and Derivatives Association introduced new trade practices in April 2009. The liquidity of the MiJ has increased since the Japan Securities Clearing Corporation started operating as a central counterpart for the MiJ in July 2011. The price discovery ability of the MiJ has also increased since then.

Contingent credit default swaps: accurate and approximate pricing

In this paper, we analyze the pricing of contingent credit default swaps (CCDSs), which provide protection against default losses in derivative transactions. In a framework with both asset and interest rate risk, we obtain a meaningful semi-analytical solution for CCDS prices with an interest rate swap as underlying. Our model yields three major contributions.1. CCDSs have several properties that fundamentally differ from those of CDSs, despite the similar nature of the two instruments.2. We propose simple approximate pricing formulas for CCDSs. While the first one only depends on the prices of observable traded assets, i.e., the CDS quote, the value of a swaption and a zero bond, the second approximation formula additionally requires volatility information.3. We find that the approximate formulas work well in practical situations and converge to the true value for a financial institution with low default risk.

Testing sovereign contagion via changes of CDS price in European debt crisis

Much empirical research has been carried out to test the presence of contagion in European sovereign debt crisis since the beginning of 2010. In this paper I will consider contagion as a change in the transmission mechanism of shock, illustrating co-movement among the sovereign credit default swap (CDS) markets of seven European countries and the UK from November 2008 up until June 2013. By examining daily pricing data of the five-year sovereign CDS contracts of these countries, I found a large increase in the volatility in the period of crisis, and hence a correlation test is invalid, but parametric method with GARCH residual time series and quantile regression approach are applicable. The first test modelling time series’ residuals by GARCH formula shows no contagion. In the second method, slope equality tests analyse the stability in linear relationship among markets across quantile and find no evidence of contagion. This final result of no contagion during the debt crisis suggests that the reason of the sovereign risk’s propagation is the conventional interdependence among countries, not the greatness of the shock.

Wild bootstrap tests for autocorrelation in vector autoregressive models

Tests for error autocorrelation (AC) are derived under the assumption of independent and identically distributed errors. The tests are not asymptotically valid if the errors are conditionally heteroskedastic. In this article we propose wild bootstrap (WB) Lagrange multiplier tests for error AC in vector autoregressive (VAR) models. We show that the WB tests are asymptotically valid under conditional heteroskedasticity of unknown form. WB tests based on a version of the heteroskedasticity-consistent covariance matrix estimator are found to have the smallest error in rejection probability under the null and high power under the alternative. We apply the tests to VAR models for credit default swap prices and Euribor interest rates. An important result that we find is that the WB tests lead to parsimonious models while the asymptotic tests suggest that a long lag length is required to get white noise residuals.

Informed trading, heterogeneity investment, liquidity shocks and the valuation of credit default swaps

This paper explores the effect of informed trading, heterogeneity investment and liquidity shocks on the valuation of credit default swaps (CDSs). Under the condition of asymmetric information, the informed trading plays an important role in the valuation of CDS. Instruction order flow has a significant influence on CDS price. And the scope of influence changes in accordance with different time interval, company status and the size of bid-ask spread. Heterogeneity of investors seriously affects the market liquidity and subsequently affects the CDS price. The bigger heterogeneity of the investment philosophy, investment habits, investment preference and so on is the bigger risk for market liquidity, and the higher price for CDS shall be. On the contrary, the conclusion is also consistent. The effectiveness of liquidity, whether it is before or after the financial crisis, dominates the fluctuation of CDS price. The premium of liquidity accounts for 36% to 50% of the CDS price.

Pricing credit default swap with contagious risk and simulation

This paper mainly studies the pricing of credit default swap (CDS) with the loan as the reference asset, and gives a model based on the obtained conclusions. In the contract of CDS, we consider that the default of the protection’s seller is correlated with the stochastic interest rate following Vasicek model and the default state of the reference firm. We give the pricing formula of CDS and analyze the effect of the contagious risk between the counterparties on the pricing of CDS.

The Role of a Changing Market Environment for Credit Default Swap Pricing

This paper investigates the impact of a changing market environment on the pricing of credit default swaps (CDS) spreads written on debt from EURO STOXX 50 firms. A panel smooth transition regression reveals that parameter estimates of standard CDS-pricing variables are time varying depending on current values of a set of variables such as the European Central Bank's systemic stress composite index, the Sentix index for the current and future economic situation and the VStoxx. These variables describe the market's transition between different regimes, thereby reflecting the impact of substantial swings in agents' risk perception on CDS spreads. Overall, our results confirm the importance of nonlinearities in the pricing of risk derivatives during tranquil and turbulent times. Copyright © 2015 John Wiley & Sons, Ltd.

Attenuated Model of Pricing Credit Default Swap under the Fractional Brownian Motion Environment

This paper mainly discusses the pricing of credit default swap (CDS) in the fractional dimension environment. We assume that the default intensity of a firm depends on the default states of counterparty firms and the term structure of interest rates, but the contagious impact of the counterparty firm is decreasing over time, until disappears. The interest rate risk is reflected by the fractional Vasicek interest rate model. We model the firm’s default intensity in the looping default framework and derive the pricing formulas of risky bonds and credit default swap.

Pricing Loan CDS with Vasicek Interest Rate under the Contagious Model

This paper mainly studies the pricing of credit default swap with the loan as the reference asset under the primary-secondary model. In the contract of credit default swap (CDS), we consider that the defaults of the counterparties are correlated with the stochastic interest rate following Vasicek model or the default state of the reference firm. We assume that the company’s default is independent with the company’s prepayment and obtain the pricing formulas of the loan and loan CDS.

A New Default Intensity Model with Fuzziness and Hesitation

AbstractWith the increased financial market volatility, corporate defaults will suffer from the double impact of the external shocks and internal contagion effects. In the existing stochastic default intensity models, the valuation of sensitivity parameters requires a lot of historical data, however, the limited market data does not guarantee the accuracy of parameter estimation, meanwhile, due to the people have a lot of fuzziness and hesitation judgements on the default process, it is necessary for us to let the corresponding random parameter of the default intensity to be a triangular intuitionistic fuzzy interval value. In this paper, we propose a new default intensity model based on the external shocks and internal contagion effects, and introduce the triangular intuitionistic fuzzy numbers into the credit default swaps (CDS) pricing modeling to describe the fuzziness and hesitation of the default process. In the end, we get a new fuzzy form pricing formula for CDS, and by the simulation analysis, we...

The Determinants of CDS Spreads: Evidence from the Model Space

We apply Bayesian Model Averaging and a frequentistic model space analysis to assess the pricing-determinants of credit default swaps (CDS). Our study focuses on the complete model space of plausible models covering most of the variables and specifications used elsewhere in the literature, including different copula models. The approach followed supports ultimate transparency and robustness for the empirical study at hand. Using a large data-set of CDS contracts we find that CDS price dynamics can be mainly explained by factors describing firms' sensitivity to extreme market movements. More precisely, our results suggest that dynamic copula based measures of tail dependence incorporate almost all essential pricing information making other potential determinants such as Merton-type factors or variables measuring the systematic market evolution - based on simple means or principal component analysis - negligible.

Credit Derivatives and Analyst Behavior

ABSTRACT This paper presents a comprehensive analysis of the role of credit default swaps (CDS) in information production surrounding earnings announcements. First, we demonstrate that the strength of CDS price discovery prior to earnings announcements is related to the presence of private information and the illiquidity of the underlying corporate bonds, consistent with the CDS market being a preferred venue for informed trading. Next, we ask how the information revealed through CDS trading influences the output of equity and credit rating analysts. We find that post-CDS trading, the dispersion and error of earnings per share forecasts are generally reduced, and downgrades by both types of analysts become more frequent and more timely before large negative earnings surprises, suggesting that the CDS market conveys information valuable to financial analysts.

Hawkes-diffusion process and the conditional probability of defaults in the Eurozone

This study examines market information embedded in the European sovereign CDS (credit default swap) market by analyzing the sovereign CDSs of 13 Eurozone countries from January 1, 2008, to February 29, 2012, which includes the recent Eurozone debt crisis period. We design the conditional probability of defaults for the CDS prices based on the Hawkes-diffusion process and obtain the theoretical prices of CDS indexes. To estimate the model parameters, we calibrate the model prices to empirical prices obtained from individual sovereign CDS term structure data. The estimated parameters clearly explain both cross-sectional and time-series data. Our empirical results show that the probability of a huge loss event sharply increased during the Eurozone debt crisis, indicating a contagion effect. Even countries with strong and stable economies, such as Germany and France, suffered from the contagion effect. We also find that the probability of small events is sensitive to the state of the economy, spiking several times due to the global financial crisis and the Greek government debt crisis.