Credit Derivatives and Corporate Default Prediction

43 Pages Posted: 12 May 2020 Last revised: 7 Sep 2021

See all articles by Xiaoxia Ye

Xiaoxia Ye

University of Exeter Business School - Department of Finance

Fan Yu

Claremont McKenna College - Robert Day School of Economics and Finance

Ran Zhao

San Diego State University

Date Written: August 11, 2021

Abstract

There have been 128 defaults among U.S. CDS reference entities between 2001 and 2020. Within this sample, the five-year CDS spread is a significant predictor of corporate default in models with equity market covariates and firm attributes. This finding holds for forecast horizons up to 12 months, among financial and non-financial firms, within and without the great financial crisis, and is robust to the inclusion of corporate bond and equity options market information. A decomposition of the CDS spread into liquidity, physical default, and risk premium components shows that most of its predictive power for corporate default comes from the physical default component, both in- and out-of-sample. These results confirm the relevance of information contained in single-name CDS pricing to corporate default prediction.

Keywords: Credit default swap spread, corporate default prediction, physical default, default risk premium, CDS liquidity

JEL Classification: G12, G13, G17, G23, G33

Suggested Citation

Ye, Xiaoxia and Yu, Fan and Zhao, Ran, Credit Derivatives and Corporate Default Prediction (August 11, 2021). Available at SSRN: https://ssrn.com/abstract=3578188 or http://dx.doi.org/10.2139/ssrn.3578188

Xiaoxia Ye

University of Exeter Business School - Department of Finance ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

HOME PAGE: http://www.xiaoxiaye.me/

Fan Yu (Contact Author)

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
(909)607-3345 (Phone)

HOME PAGE: http://www.cmc.edu/academic/faculty/profile.asp?Fac=553

Ran Zhao

San Diego State University ( email )

5500 Campanile Dr
San Diego, CA 92182
United States

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