The Nature of the Risk-Free Asset: Evidence from Credit Default Swaps

46 Pages Posted: 8 Oct 2011 Last revised: 31 Aug 2012

See all articles by Jin Xiang

Jin Xiang

Integrated Financial Engineering Inc.

Zhiyi Qian

W. P. Carey School of Business

Date Written: February 18, 2012

Abstract

US sovereign debt is widely regarded as risk-free on nominal terms. However, between January 2008 and September 2010, US sovereign credit default swaps (CDS) traded at premium to a sample of US corporate CDSs. The implied default probabilities from CDS premiums show that the US government is more likely to default than these firms. We find no evidence that changes in fundamental default risk are responsible for this premium difference. Traditional explanations such as differences in recovery rates, counterparty risk and cheapest-to-deliver options also cannot explain it. Changes in comovement “factors” that represent spillover effects from the default risk of European countries, and liquidity, appear to drive the observed premium difference.

Keywords: Financial market, credit default swaps, default bet anomaly, default risk, comovement

JEL Classification: G12

Suggested Citation

Xiang, Jin and Qian, Zhiyi, The Nature of the Risk-Free Asset: Evidence from Credit Default Swaps (February 18, 2012). Available at SSRN: https://ssrn.com/abstract=1939988 or http://dx.doi.org/10.2139/ssrn.1939988

Jin Xiang (Contact Author)

Integrated Financial Engineering Inc. ( email )

51 Monroe Pl, Suite 1100
Rockville, MD 20850
United States
3013096560 (Phone)

Zhiyi Qian

W. P. Carey School of Business ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
63
Abstract Views
643
rank
358,641
PlumX Metrics