Market Vs Model Credit Default Swap Spreads: Mind the Gap!

European Financial Management, Forthcoming

Posted: 6 Mar 2008 Last revised: 31 Jul 2010

See all articles by Lara Cathcart

Lara Cathcart

Imperial College Business School

Lina El-Jahel

University of Auckland Business School

Mascia Bedendo

University of Bologna - Department of Management

Date Written: January 2, 2008

Abstract

This paper provides important empirical insights into the relation between equity and credit variables. For this purpose, we compare market and model credit default swaps (CDS) spreads for a sample of obligors over the period 2002-2005, where model spreads are obtained from a popular structural model based on equity market variables. We find that, in general, model spreads display a significant correlation with market spreads. However, the gap between the two widens substantially when equity volatility is high. We investigate various determinants of this gap, in order to highlight potential shortcomings of the model. Furthermore, we test to what extent model spreads predict market spreads. Finally, we analyze the convergence properties of the gap between empirical and theoretical spreads.

Keywords: Equity volatility, Credit spreads, Structural models , Trading strategies

JEL Classification: G21, C22, G10

Suggested Citation

Cathcart, Lara and El-Jahel, Lina and Bedendo, Mascia, Market Vs Model Credit Default Swap Spreads: Mind the Gap! (January 2, 2008). European Financial Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1099922

Lara Cathcart

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom
+44 (0) 20 7594 9126 (Phone)
+44 (0) 20 7594 9189 (Fax)

Lina El-Jahel

University of Auckland Business School ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Mascia Bedendo (Contact Author)

University of Bologna - Department of Management ( email )

Via Capo di Lucca 34
Bologna, Bologna 40126
Italy

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
2,161
PlumX Metrics