Economics at your fingertips  

Modeling CDS spreads: A comparison of some hybrid approaches

Luca Vincenzo Ballestra, Graziella Pacelli and Davide Radi

Journal of Empirical Finance, 2020, vol. 57, issue C, 107-124

Abstract: According to the credit risk model proposed by Cathcart and El-Jahel (2006), default can occur either expectedly, when a certain signaling variable breaches a lower barrier, or unexpectedly, as the first jump of a Poisson process, whose intensity depends on the signaling variable itself and on the interest rate. In the present paper we test the performances of such a model and of other three models generalized by it in fitting the term structure of credit default swap (CDS) spreads. In order to do so, we derive a semi-analytical formula for pricing CDSs and we use it to fit the observed term structures of 65 different CDSs. The analysis reveals that all the model parameters yield a relevant contribution to credit spreads. Moreover, if the dependence of the default intensity on both the signaling variable and the interest rate is removed, the pricing of CDSs becomes very simple, from both the analytical and the computational standpoint, while the goodness-of-fit is reduced by only a few percentage points. Therefore, when using the credit risk model proposed by Cathcart and El-Jahel (2006), assuming a constant default intensity provides an interesting and efficient compromise between parsimony and goodness-of-fit. Furthermore, by fitting the term structure of CDS spreads on a period of about twelve years, we find that the parameters of the model with constant default are rather stable over time, and the goodness-of-fit is maintained high.

Keywords: Default risk; Credit default swap; CDS; Hybrid model (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
Full text for ScienceDirect subscribers only

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:

DOI: 10.1016/j.jempfin.2020.03.001

Access Statistics for this article

Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

More articles in Journal of Empirical Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().

Page updated 2021-06-30
Handle: RePEc:eee:empfin:v:57:y:2020:i:c:p:107-124