Contagion and Excess Correlation in Credit Default Swaps

43 Pages Posted: 4 Oct 2011

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2011

Abstract

This paper documents an increase in the correlations between credit default swap (CDS) spread changes during the credit crisis and investigates the sources of that increase. One possible explanation is that correlations increased because fundamental values became more correlated during the crisis. However, I find that changes in the fundamental determinants of credit risk account for only 20% of the increase in correlations on average. Further, I show that changes in counterparty risk did not affect correlations during the turmoil. In contrast, I find that changes in liquidity risk contributed to the increase in correlations; however, liquidity alone cannot explain the full increase. Finally, I show that a systematic re-pricing of credit risk, as evidenced by increased volatility in the default risk premium, was the main factor that amplified correlations.

Keywords: CDS, credit default swap, contagion correlation

Suggested Citation

Anderson, Mike, Contagion and Excess Correlation in Credit Default Swaps (October 1, 2011). Available at SSRN: https://ssrn.com/abstract=1937998 or http://dx.doi.org/10.2139/ssrn.1937998

Mike Anderson (Contact Author)

Mike Anderson ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

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