An Empirical Study of Credit Default Swaps

We examine the pricing of Asian and non-Asian credit default swaps that traded during the 1997 to 1999 time period. We employ two credit risk models, Duffie and Singleton (1999) and Jarrow and Turnbull (1995). We argue that credit default swaps should have a positive economic value since credit spreads reflect differences in liquidity as well as credit risk. However, in the presence of moral hazard we expect to see negative economic values since asymmetric information would motivate sellers of credit default swaps to demand a “restructuring premium”. While we generally find positive economic values for credit default swaps, both models find negative economic values for Asian credit default swaps during the recent Asian currency crisis, which we attribute to moral hazard.Credit default swaps, moral hazard, recovery rates, asymmetric information

The History of the Quantitative Methods in Finance Conference Series. 1992-2007

This report charts the history of the Quantitative Methods in Finance (QMF) conference from its beginning in 1993 to the 15th conference in 2007. It lists alphabetically the 1037 speakers who presented at all 15 conferences and the titles of their papers.

An Extended Structural Credit Risk Model (forthcoming in the Icfai Journal of Financial Risk Management; all copyrights rest with the Icfai University Press)

This paper presents an extended structural credit risk model that pro- vides closed form solutions for fixed and floating coupon bonds and credit default swaps. This structural model is an "extended" one in the following sense. It allows for the default free term structure to be driven by the a multi-factor Gaussian model, rather than by a single factor one. Expected default occurs as a latent diffusion process first hits the default barrier, but the diffusion process is not the value of the firm's assets. Default can be "expected" or "unexpected". Liquidity risk is correlated with credit risk. It is not necessary to disentangle the risk of unexpected default from liquidity risk. A tractable and accurate recovery assumption is proposed.structural credit risk model, Vasicek model, Gaussian term structure model, bond pricing, credit default swap pricing, unexpected default, liquidity risk.

The pricing of risk in European credit and corporate bond markets

This paper investigates the determinants of the default risk premia embedded in the European credit default swap spreads. Using a modified version of the intertemporal capital asset pricing model, we show that default risk premia represent compensation for bearing exposure to systematic risk and to a new common factor capturing the proneness of the asset returns to extreme events. This new factor arises naturally because the returns on defaultable securities are more likely to have fat tails. The pricing implications of this new factor are not limited to credit markets only. We find that this common factor is priced consistently across a broad spectrum of corporate bond portfolios. In addition, our asset pricing tests also document patterns that are consistent with the so called "flight to quality" effect. JEL Classification: G12, G13, G15credit default swap, default risk premium, European corporate bond markets, European credit market, risk factors

Decomposing the Returns on European Debt

Common variation in the prices of European corporate debt may not always be associated with a rational response to an increase in the relative importance of a macroeconomic risk factor. Building on Campbell’s ICAPM framework, we show that risk premia of assets with nonlognormal return distributions represent compensation not only for exposure to macroeconomic factors but also for unexpected revisions to these assets’ return distributions, such as sudden increases in the likelihood of extreme events. If such revisions happen across assets almost simultaneously, perhaps as a systemic response to a large credit event, they can induce covariation in risk premia unrelated to the time variation of the priced macroeconomic factors. Our study presents evidence from the European debt markets which supports this theory. The asset pricing tests also document patterns consistent with the “flight to quality” effect for European corporate bonds.

Credit Risk and the Pricing of Japanese Yen Interest Rate Swaps

In this paper, we investigate the pricing of Japanese yen interest rate swaps during the period 1990-96. We obtain measures of the spreads of the swap rates over comparable Japanese Government Bonds (JGBs) for different maturities and analyze the relationship between the swap spreads and credit risk variables

Credit Risk and the Yen Interest Rate Swap Market

In this paper, we investigate the pricing of Japanese yen interest rate swaps during the period 1990-96. We obtain measures of the spreads of the swap rates over comparable Japanese Government Bonds (JGBs) for different maturities and analyze the relationship between the swap spreads and credit risk variables. Our empirical results in the yen swap market indicate that: 1) the commonly-used assumption of lognormal default-free interest rates and swap spreads is strongly rejected by the data, 2) the term structure of swap spreads displays a humped-shape, and 3) the shocks in the yen swap spread are negatively correlated with the shocks in the comparable default-free spot rates, especially for longer maturities. Our analysis also indicates that yen swap spreads behaved very differently from the credit spreads on Japanese corporate bonds in the early nineties. In contrast to Japanese corporate bonds, we find that the yen swap spread is also significantly related to proxies for the long-term credit risk factor. Furthermore, the swap spread is negatively related to the level and slope of the term structure and positively related to the curvature, indicating that the credit "optionality" is priced in the swap rate. Thus, overall, the yen swap market was sensitive to credit risk during the period of our study

Credit Risk and the Yen Interest Rate Swap Market

In this paper, we investigate the pricing of Japanese yen interest rate swaps during the period 1990-96. We obtain measures of the spreads of the swap rates over comparable Japanese Government Bonds (JGBs) for di erent maturities and analyze the relationship between the swap spreads and credit risk variables. Our empirical results in the yen swap market indicate that: 1) the commonly-used as- sumption of lognormal default-free interest rates and swap spreads is strongly rejected by the data, 2) the term structure of swap spreads displays a humped-shape, and 3) the shocks in the yen swap spread are negatively correlated with the shocks in the comparable default-free spot rates, especially for longer maturities. Our analysis also indicates that yen swap spreads behaved very di erently from the credit spreads on Japanese corporate bonds in the early nineties. In contrast to Japanese corporate bonds, we find that the yen swap spread is also significantly related to proxies for the longterm credit risk factor. Furthermore, the swap spread is negatively related to the level and slope of the term structure and positively related to the curvature, indicating that the credit \optionality" is priced in the swap rate. Thus, overall, the yen swap market was sensitive to credit risk during the period of our study