Measuring Credit Spread Risk: Incorporating the Tails

24 Pages Posted: 20 Jan 2003

See all articles by Rachel A.J. Pownall

Rachel A.J. Pownall

Tilburg University - Department of Finance; Maastricht University - Department of Finance

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Date Written: October 2002

Abstract

It is widely known that the small but looming possibility of default renders the expected return distribution for financial products containing credit risk to be highly skewed and fat tailed. In this paper, we apply recent techniques developed for incorporating the additional risk faced by changes in swap spreads. Using data from the US, UK, Germany, and Japan, we find that the risk faced from large spread widenings and tightenings is grossly underestimated. Estimation of swap spread risk is dramatically improved when the severity of the fat tails is measured and incorporated into current estimation techniques.

Keywords: Market risk, value-at-risk, extreme value theory, parametric distributions, backtesting

JEL Classification: M, M41, G3, G24

Suggested Citation

Pownall, Rachel Ann Jane and Huisman, Ronald, Measuring Credit Spread Risk: Incorporating the Tails (October 2002). ERIM Report Series Reference No. ERS-2001-95-F&A. Available at SSRN: https://ssrn.com/abstract=371037

Rachel Ann Jane Pownall (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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