Some Determinants of the Price of Default Risk

Ron Anderson ()

FMG Discussion Papers from Financial Markets Group

Abstract: In this paper we study the pricing of credit risk as re°ected in the market for credit default swaps (CDS) between 2003 and 2008. This market has newly emerged as the reference for credit risk pricing because of its use of standardized contract speci¯cations and has achieved a higher level of liquidity than typically prevails in the markets for the underlying notes and bonds of the named corporate issuers. We initiate our exploration by studying a particular case which allows us to set out some of the issues of CDS pricing in a simple way. We show that for the purposes of accounting for relatively short-term changes of CDS spreads, an approach based on the structural (or ¯rm-value based) models of credit risk faces an important obstacle in that reliable information about the ¯rm's liabilities required to calculate the \\distance to default¶ are available only quarterly or in some cases annually. Thus structural models account for short-term movements in credit spreads largely by changes in the issuer's equity price. In the case studied we show the e®ect of equity returns in explaining weekly changes of spreads is insigni¯cant and of the wrong sign. In examination of particular episodes when the CDS spread was particularly delinked from the ¯rm's equity series, we ¯nd that a likely explanation is changes in expectations about the ¯rm's planned capital market operations. Since these are hard to capture in an observed proxy variable, we argued that this motivates the use of latent variable models that have recently been employed in the credit risk literature. We further see that movements in the CDS spreads for the particlar name chosen are highly correlated with an index of CDS spreads for industrial Blue-chip names.

Date: 2008-06
New Economics Papers: this item is included in nep-rmg
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp615.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fmg:fmgdps:dp615

Access Statistics for this paper

More papers in FMG Discussion Papers from Financial Markets Group
Bibliographic data for series maintained by The FMG Administration ().