Review of Financial Studies Vol. 22 No. 12 2009
Explaining Credit Default Swap Spreads with the Equity Volatility and Jump Risks of Individual Firms
Abstract
[This paper attempts to explain the credit default swap (CDS) premium, using a novel approach to identify the volatility and jump risks of individual firms from high-frequency equity prices. Our empirical results suggest that the volatility risk alone predicts 48% of the variation in CDS spread levels, whereas the jump risk alone forecasts 19%. After controlling for credit ratings, macroeconomic conditions, and firms' balance sheet information, we can explain 73% of the total variation. We calibrate a Merton-type structural model with stochastic volatility and jumps, which can help to match credit spreads after controlling for the historical default rates. Simulation evidence suggests that the high-frequency-based volatility measures can help to explain the credit spreads, above and beyond what is already captured by the true leverage ratio.]
- Volume
- 22
- Issue
- 12
- Pages
- 5099-5131
- Sources
- bibtex:phds-export.bib