An Empirical Analysis of Equity Default Swaps (I): Univariate Insights

Abstract

The aim of this paper is to describe a new methodology to assess the risk of any Equity Default Swap (EDS). We show that as credit ratings can measure counter-party risk, it is technically possible to provide a quantitatively derived "through the cycle" risk estimate for EDSs. Whereas in the case of CDSs, the assessment is relevant at an issuer level, for EDSs it makes sense at an issue level. The reason for such a difference is that unlike for pure credit risk, the risk on EDSs directly depends on equity market conditions at origination and is therefore not fully counter-party specific. The outcome of this paper is that though this new methodology is purely quantitative, its level of performance is surprisingly high with superior results compared to previously developed techniques.

Keywords: Equity Default Swap, EDS

JEL Classification: C14, C32, C81