An Empirical Analysis of Equity Default Swaps (I): Univariate Insights

The aim of this paper is to describe a new methodology to assess the risk of any Equity Default Swap (EDS). We show that as credit ratings can measure counter-party risk, it is technically possible to provide a quantitatively derived “through the cycle” risk estimate for EDSs. Whereas in the case of CDSs, the assessment is relevant at an issuer level, for EDSs it makes sense at an issue level. The reason for such a difference is that unlike for pure credit risk, the risk on EDSs directly depends on equity market conditions at origination and is therefore not fully counterparty specific. The outcome of this paper is that though this new methodology is purely quantitative, its level of performance is surprisingly high with superior results compared to previously developed techniques.EDS Equity Default Swap

An Empirical Analysis of Equity Default Swaps (II): Multivariate Insights

Equity default swaps (EDS) - contracts that trigger a payment when the underlying equity price falls below a predetermined level - have attracted much attention recently because of their similarities to credit default swaps (CDS) on the one hand, and American digital puts on the other. Particular interest has been received by Collateral- ized debt obligations (CDOs) referencing a portfolio of EDSs, which not only requires the univariate assessment of the risks inherent in EDSs, but also the analysis of dependencies between EDSs (and other asset classes). In this paper, we specifically address correlation or dependency aspects of EDSs, by applying techniques developed for estimating default correlation. Based on Standard & Poor’s CreditPro and Compustat (North America) databases, extensive empirical research is presented. Amongst the main findings are that EDS correlations for standard strikes/barriers of 30% are significantly higher than default correlations, and increase in barrier level, but only for strikes above 50%. This indicates a barrier dependent correlation concept.EDS Equity Default Swap Correlation