Credit Spreads, Leverage and Volatility: A Cointegration Approach

Federico Maglione ()
Additional contact information
Federico Maglione: Scuola Normale Superiore

A chapter in Mathematical and Statistical Methods for Actuarial Sciences and Finance, 2022, pp 327-332 from Springer

Abstract: Abstract This work documents the existence of a cointegration relationship between credit spreads, leverage and volatility for a large set of US companies. It is shown that accounting for the long-run equilibrium dynamic between these variables is essential to correctly explain credit spread changes. Using a novel structural model in which equity is modelled as a compound option on the firm’s assets, a new methodology for estimating the unobservable market asset value and volatility is developed. The proposed model allows to reduce pricing errors in predicting credit spreads. In terms of correlation analysis, it is shown that not accounting for the long-run equilibrium equation embedded in an Error Correction Mechanism (ECM) results into a misspecification problem when regressing a set of explanatory variables onto the spread changes. Once credit spreads, leverage and volatility are correctly modelled, the fit of the regressions sensibly increases if compared to the results of previous research.

Keywords: Credit spreads; Financial leverage; Asset volatility; Cointegration; Compound options (search for similar items in EconPapers)
Date: 2022
References: Add references at CitEc
Citations:

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

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:spr:sprchp:978-3-030-99638-3_53

Ordering information: This item can be ordered from
http://www.springer.com/9783030996383

DOI: 10.1007/978-3-030-99638-3_53

Access Statistics for this chapter

More chapters in Springer Books from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().