An Analysis of the Determinants of Credit Default Swap Spread Changes Before and During the Subprime Financial Turmoil

45 Pages Posted: 1 Sep 2010

Date Written: March 22, 2010

Abstract

This paper analyzes the determinants of credit default swap spread changes for a large sample of US non-financial companies over the period between January 2002 and March 2009. In our analysis we use variables that the literature has found have an impact on CDS spreads and, in order to account for possible non-linear effects, the theoretical CDS spreads predicted by the Merton model. We show that our set of variables is able to explain more than 50% of CDS spread variations both before and after July 2007, when the current financial turmoil began. We also document that since the onset of the crisis CDS spreads have become much more sensitive to the level of leverage while volatility has lost its importance. Using a principal component analysis we also show that since the beginning of the crisis CDS spread changes have been increasingly driven by a common factor, which cannot be explained by indicators of economic activity, uncertainty, and risk aversion.

Keywords: Credit Default Swaps, Bond Spreads, Credit Risk, Merton Model

JEL Classification: G12, G13

Suggested Citation

Di Cesare, Antonio and Guazzarotti, Giovanni, An Analysis of the Determinants of Credit Default Swap Spread Changes Before and During the Subprime Financial Turmoil (March 22, 2010). Bank of Italy Temi di Discussione (Working Paper) No. 749. Available at SSRN: https://ssrn.com/abstract=1670045 or http://dx.doi.org/10.2139/ssrn.1670045

Antonio Di Cesare (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

Giovanni Guazzarotti

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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