An Empirical Investigation of CDS Spreads Using a Regime-Switching Default Risk Model

Andreas Milidonis ()

North American Actuarial Journal, 2016, vol. 20, issue 3, 252-275

Abstract: Default risk in equity returns can be measured by structural models of default. In this article we propose a credit warning signal (CWS) based on the Merton Default Risk (MDR) model and a Regime-Switching Default Risk (RSDR) model. The RSDR model is a generalization of the MDR model, comprises regime-switching asset distribution dynamics, and thus produces more realistic default probability estimates in cases of deteriorating credit quality. Alternatively, it reduces to the MDR model. Using a dataset of U.S. credit default swap (CDS) contracts around the 2007-8 crisis we construct rating-based indices to investigate the MDR and RSDR implied probabilities of default in relation to the market-observed CDS spreads. The proposed CWS measure indicates an increase in implied default probabilities several months ahead of notable increases in CDS spreads.

Date: 2016
References: Add references at CitEc
Citations:

Downloads: (external link)
http://hdl.handle.net/10.1080/10920277.2016.1180996 (text/html)
Access to full text is restricted to subscribers.

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:taf:uaajxx:v:20:y:2016:i:3:p:252-275

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/uaaj20

DOI: 10.1080/10920277.2016.1180996

Access Statistics for this article

North American Actuarial Journal is currently edited by Kathryn Baker

More articles in North American Actuarial Journal from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().