Skewed Credit Markets
32 Pages Posted: 15 Sep 2011
Date Written: September 15, 2011
Substantial empirical research has investigated the determinants of credit default swap (CDS) premia. Beside the well-documented impact of implied volatility on spreads only little is known about the informational content of equity option prices to explain the cross-section of CDS spreads. Our study fills this gap. A recent strand in the literature finds negative risk premia in CDS spreads for the steepness of the stock option smile. However, this method is unable to distinguish between implied volatility skews and smiles which are frequently encountered in the term structures of single name options. To circumvent this problem our study investigates the dependence between corporate CDS spreads and the skewness of the implied return distribution. Consistent with the predictions of structural credit models we find that skewness has a signicantly negative impact of on CDS premia. This effect is strongest for firms with high implied volatility and volatility risk levels.
Furthermore, we investigate the impact of systematic risk factors on the cross section of CDS spreads. Our findings reveal significantly positive impacts of systematic risk and co-skewness risk on single name contracts. They are robust to controlling for market- and firm-level control variables identified in the existing literature, as well as to different subperiods such as the 2008/09 subprime crisis.
Keywords: credit default swap, implied volatility
JEL Classification: G12, G13
Suggested Citation: Suggested Citation