Credit‐default swap rates and equity volatility: a nonlinear relationship

Fathi Abid and Nader Naifar

Journal of Risk Finance, 2006, vol. 7, issue 4, 348-371

Abstract: Purpose - The aim of this paper is to study the impact of equity returns volatility of reference entities on credit‐default swap rates using a new dataset from the Japanese market. Design/methodology/approach - Using a copula approach, the paper models the different relationships that can exist in different ranges of behavior. It studies the bivariate distributions of credit‐default swap rates and equity return volatility estimated with GARCH (1,1) and focus on one parameter Archimedean copula. Findings - First, the paper emphasizes the finding that pairs with higher rating present a weaker dependence coefficient and then, the impact of equity returns volatility on credit‐default swap rates is higher for the lowest rating class. Second, the dependence structure is positive and asymmetric indicating that protection sellers ask for higher credit‐default swap returns to compensate the higher credit risk incurred by low rating class. Practical implications - The paper has several practical implications that are of value for financial hedgers and engineers, loan market participants, financial regulators, government regulators, central banks, and risk managers. Originality/value - The paper also illustrates the potential benefits of equity returns volatility of reference entities as a proxy of default risk. These simplifications could be lifted in future research on this theme.

Keywords: Credit; Equity capital; Japan (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:jrfpps:15265940610688946

DOI: 10.1108/15265940610688946

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