Implied Equity and Firm Asset Volatility in Credit Default Swap Premia
61 Pages Posted: 25 Jun 2019
Date Written: April 02, 2019
We investigate the informational content of credit default swap (CDS) spreads for future volatility of firm assets and equity, and compare our results with information provided by historical volatilities. CDS implied asset (equity) volatilities explain as much as 68.40% (only 18.56%) of the cross-sectional variation in future realized asset (equity) volatilities. This informational content is clearly superior, and almost subsumes (is similar, and complements), the informational content of historical asset (equity) volatilities. We show that these results are explained by the leverage effect component in equity volatility, and the interconnection between leverage and asset volatility documented earlier in the literature.
Keywords: Credit Default Swap, Implied Firm Asset Volatility, Implied Equity Volatility, Leverage Effect
JEL Classification: G12, G13, G14, G17
Suggested Citation: Suggested Citation