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
Date Written: April 2, 2019
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: Suggested Citation