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Measuring Credit Spread Risk

Rachel Pownall () and Ronald Huisman

No ERS-2002-95-F&A, ERIM Report Series Research in Management from Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam

Abstract: It is widely known that the small but looming possibility of default renders the expected return distribution for financial products containing credit risk to be highly skewed and fat tailed. In this paper we apply recent techniques developed for incorporating the additional risk faced by changes in swap spreads. Using data from the US, UK, Germany, and Japan, we find that the risk faced from large spread widenings and tightenings is grossly underestimated. Estimation of swap spread risk is dramatically improved when the severity of the fat tails is measured and incorporated into current estimation techniques.

Keywords: Market Risk; backtesting; extreme Value theory; parametric distributions; value-at-risk (search for similar items in EconPapers)
JEL-codes: G24 G3 M M41 (search for similar items in EconPapers)
Date: 2002-10-22
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