Are CDS Spreads Predictable? An Analysis of Linear and Non-Linear Forecasting Models

34 Pages Posted: 23 Nov 2012 Last revised: 7 Mar 2019

See all articles by Davide E. Avino

Davide E. Avino

University of Liverpool; Financial Mathematics and Computation Cluster

Ogonna Nneji

University of Reading - ICMA Centre

Date Written: March 1, 2014

Abstract

This paper investigates the forecasting performance for CDS spreads of both linear and nonlinear models by analysing the iTraxx Europe index during the financial crisis period which began in mid-2007. The statistical and economic significance of the models’ forecasts are evaluated by employing various metrics and trading strategies, respectively. Although these models provide good in-sample performances, we find that the non-linear Markov switching models underperform linear models out-of-sample. In general, our results show some evidence of predictability of iTraxx index spreads. Linear models, in particular, generate positive Sharpe ratios for some of the strategies implemented, thus shedding some doubts on the efficiency of the European CDS index market.

Keywords: Credit default swap spreads, iTraxx, Forecasting, Markov switching, Market efficiency, Technical trading rules

JEL Classification: G01, G17, G20, C22, C24

Suggested Citation

Avino, Davide E. and Nneji, Ogonna, Are CDS Spreads Predictable? An Analysis of Linear and Non-Linear Forecasting Models (March 1, 2014). International Review of Financial Analysis, Vol. 34, pp. 262-274, 2014, Available at SSRN: https://ssrn.com/abstract=2180022 or http://dx.doi.org/10.2139/ssrn.2180022

Davide E. Avino (Contact Author)

University of Liverpool ( email )

Chatham Street
Liverpool, L69 7ZA
United Kingdom

Financial Mathematics and Computation Cluster

Dublin
Ireland

Ogonna Nneji

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

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