Valuation of Systematic Risk in the Cross-Section of Credit Default Swap Spreads
58 Pages Posted: 17 Nov 2013
Date Written: August 20, 2013
This paper analyses the pricing of systematic risk factors in credit default swap contracts in a two-stage empirical framework. In the first pass, we estimate contract-specific sensitivities to several systematic risk factors by time-series regressions using quoted credit default swap (CDS) spreads of 339 U.S. entities from 2004 to 2010. We find that the credit market climate, the cross-market correlation and the market volatility explain CDS spread changes. In the second pass, we examine by crosssection regressions whether the contract-specific sensitivities to these systematic risk factors are priced in the cross-section of swap contracts by controlling for individual risk factors such as credit ratings, liquidity and leverage. We find that our basic risk factors explain about 83% of the CDS spreads prior to the crisis and about 90% during the crisis.
Keywords: Credit Derivatives, Cross-section of Credit Default Swap Spreads, Systematic Risk
JEL Classification: C16, C50, G21, G24
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