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Working paper

Valuation of Systematic Risk in the Cross-Section of Credit Default Swap Spreads

Finance Systemic risk United States of America
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apo-nid67382.pdf 1.29 MB

This paper analyses the pricing of systematic risk factors in credit default swap contracts in a two-stage empirical framework. In the first pass, we estimate contract specific sensitivities to several systematic risk factors by time-series regressions using quoted credit default swap (CDS) spreads of 339 U.S. entities from 2004 to 2010. We find that the credit market climate, the cross-market correlation and the market volatility explain CDS spread changes. In the second pass, we examine by crosssection regressions whether the contract-specific sensitivities to these systematic risk factors are priced in the cross-section of swap contracts by controlling for individual risk factors such as credit ratings, liquidity and leverage. We find that our basic risk factors explain about 83% of the CDS spreads prior to the crisis and about 90% during the crisis.

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