Credit-Implied Volatility

Bryan Kelly, Gerardo Manzo and Diogo Palhares

Financial Analysts Journal, 2025, vol. 81, issue 2, 89-116

Abstract: We define and construct a credit-implied volatility (CIV) surface from the firm-by-maturity panel of credit default swap (CDS) spreads. We use this framework to organize the behavior of corporate credit markets into three stylized facts. First, CIV exhibits a steep moneyness smirk. Second, the joint dynamics of credit spreads on all firms are captured by three interpretable factors in the CIV surface. Third, the cross-section of CDS risk premia is fully explained by exposures to CIV surface shocks. We propose a structural model for joint asset behavior of all firms that is characterized by stochastic volatility and time-varying downside tail risk in aggregate asset growth.

Date: 2025
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DOI: 10.1080/0015198X.2025.2473251

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