A Value at Risk Analysis of Credit Default Swaps

34 Pages Posted: 20 Nov 2008

See all articles by Burkhard Raunig

Burkhard Raunig

Austrian National Bank - Economic Studies Division

Martin Scheicher

European Central Bank (ECB)

Multiple version iconThere are 2 versions of this paper

Date Written: November 17, 2008

Abstract

We investigate the risk of holding credit default swaps (CDS) in the trading book and compare the Value at Risk (VaR) of a CDS position to the VaR for investing in the respective firm's equity using a sample of CDS - stock price pairs for 86 actively traded firms over the period from March 2003 to October 2006. We find that the VaR for a stock is usually far larger than the VaR for a position in the same firm's CDS. However, the ratio between CDS and equity VaR is markedly smaller for firms with high credit risk. The ratio also declines for longer holding periods. We also observe a positive correlation between CDS and equity VaR. Panel regressions suggest that our findings are consistent with qualitative predictions of the Merton (1974) model.

Keywords: Credit Default Swap, Value at Risk, Structural Credit Risk Models

JEL Classification: E43, G12, G13

Suggested Citation

Raunig, Burkhard and Scheicher, Martin, A Value at Risk Analysis of Credit Default Swaps (November 17, 2008). ECB Working Paper No. 968. Available at SSRN: https://ssrn.com/abstract=1297184

Burkhard Raunig (Contact Author)

Austrian National Bank - Economic Studies Division ( email )

POB 61
Vienna, A-1011
Austria
+43 1 404 20 7219 (Phone)
+43 1 404 20 7299 (Fax)

Martin Scheicher

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 (Phone)
+49 69 1344 7949 (Fax)

HOME PAGE: http://www.ecb.europa.eu

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