Component Structure of Credit Default Swap Spreads and Their Determinants

45 Pages Posted: 9 Dec 2017

See all articles by Ramaprasad Bhar

Ramaprasad Bhar

UNSW Business School, Risk and Actuarial Studies

David B. Colwell

UNSW Australia Business School, School of Banking and Finance; Financial Research Network (FIRN)

Peipei Wang

Deakin University

Multiple version iconThere are 2 versions of this paper

Date Written: October 4, 2017

Abstract

In this paper, we decompose credit default swap (CDS) spreads into a transitory component and a persistent component and test how these components are affected by the theoretical explanatory variables. We find significant but differing impacts of these explanatory variables on the extracted components. For example, equity volatility seems to have a larger influence on the transitory component, suggesting that its effect may be mostly short-lived, while our proxy for illiquidity has a greater impact on the persistent component indicating its more enduring effect. Also, the slope of the yield curve has impacts with opposite signs on the two components and so our analysis thus helps address the conflicting results reported in earlier studies without such a component framework. These results indicate that a two-factor formulation may be needed to model CDS options.

Keywords: CDS Spread, Component Structure, State Space Model

Suggested Citation

Bhar, Ramaprasad and Colwell, David B. and Wang, Peipei, Component Structure of Credit Default Swap Spreads and Their Determinants (October 4, 2017). Available at SSRN: https://ssrn.com/abstract=3082634 or http://dx.doi.org/10.2139/ssrn.3082634

Ramaprasad Bhar (Contact Author)

UNSW Business School, Risk and Actuarial Studies ( email )

Sydney, NSW 2052
Australia

David B. Colwell

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia
+61 (2) 9385 5851 (Phone)
+61 (2) 9385 6347 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Peipei Wang

Deakin University ( email )

75 Pigdons Road
Victoria, Victoria 3216
Australia
61-03-92446906 (Phone)

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