Jump and Cojump Risk in Subprime Home Equity Derivatives

Abstract:     
I analyze the jump risk in the ABX index of subprime home equity credit default swaps and CME housing futures. Using estimators of the jump and cojump components of security prices, I document: (1) significant jumps in the ABX as early as September 2006, well before any problems in the mortgage market were discussed in the press or policy circles; (2) news explains up to 56% of the jump risk; (3) the return variation due to jumps in the housing futures is larger than the ABX; (4) 25 significant cojump episodes between the AAA ABX and the 12-month housing futures; (5) a predictive model that explains up to 85% of the jump risk; (6) a 20 point slope in the housing futures curve leads to an expected jump of -1.4% in the BBB- ABX; (7) jumps explain up to 50% of the value-at-risk exceedences which occur at almost three times the expected rate.

Working Paper Series