Credit Default Swaps, the Leverage Effect, and Cross-Sectional Predictability of Equity and Firm Asset Volatility

78 Pages Posted: 25 Jun 2019 Last revised: 14 Jan 2021

See all articles by Santiago Forte

Santiago Forte

ESADE Business School, Ramon Llull University

Lidija Lovreta

EADA Business School

Date Written: April 2, 2019

Abstract

We investigate the informational content of credit default swap (CDS) spreads for future volatility of (firm) assets and equity. In the cross-section, CDS spreads are significantly more informative about future asset than equity volatility. The informational content of historical and option implied volatilities is generally lower than that of CDS implied volatilities but exhibits the same pattern. We argue both theoretically and empirically that this common pattern reflects a fundamental difference in the cross-sectional predictability of asset and equity volatility. This difference lies in the leverage effect component in equity volatility, and the interconnection between leverage and asset volatility.

Keywords: Credit Default Swap, Implied Firm Asset Volatility, Implied Equity Volatility, Leverage Effect

JEL Classification: G12, G13, G14, G17

Suggested Citation

Forte, Santiago and Lovreta, Lidija, Credit Default Swaps, the Leverage Effect, and Cross-Sectional Predictability of Equity and Firm Asset Volatility (April 2, 2019). ESADE Business School Research Paper, Available at SSRN: https://ssrn.com/abstract=3406756 or http://dx.doi.org/10.2139/ssrn.3406756

Santiago Forte (Contact Author)

ESADE Business School, Ramon Llull University ( email )

Av. Torreblanca 59
Sant Cugat del Vallès, Barcelona 08172
Spain

HOME PAGE: http://www.santiagoforte.com

Lidija Lovreta

EADA Business School ( email )

CIF ESG08902645
C/ Aragó 204
Barcelona, CP 08011
Spain

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