Skip to main content Accessibility help
×
Home

What Drives the Commonality between Credit Default Swap Spread Changes?

  • Mike Anderson

Abstract

This paper documents an increase in the comovement between credit default swap (CDS) spread changes during the 2007–2009 crisis and investigates the source of that increase. One possible explanation is that comovement increased because fundamental values became more correlated. However, I find that changes in fundamentals account for only 23% of the increase in covariance. The remaining increase is attributed to changes in liquidity and the market price of default risk. In contrast, counterparty risk played an insignificant role. Although both contributed, the increase in covariance was driven more by variation in exposures than factor variance–covariance.

    • Send article to Kindle

      To send this article to your Kindle, first ensure no-reply@cambridge.org is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about sending to your Kindle. Find out more about sending to your Kindle.

      Note you can select to send to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be sent to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.

      Find out more about the Kindle Personal Document Service.

      What Drives the Commonality between Credit Default Swap Spread Changes?
      Available formats
      ×

      Send article to Dropbox

      To send this article to your Dropbox account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your <service> account. Find out more about sending content to Dropbox.

      What Drives the Commonality between Credit Default Swap Spread Changes?
      Available formats
      ×

      Send article to Google Drive

      To send this article to your Google Drive account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your <service> account. Find out more about sending content to Google Drive.

      What Drives the Commonality between Credit Default Swap Spread Changes?
      Available formats
      ×

Copyright

Corresponding author

* Anderson (corresponding author), mander19@gmu.edu, School of Business, George Mason University.

Footnotes

Hide All
1 I am grateful for helpful discussion and suggestions from Joost Driessen and Spencer Martin (the referees) and from Jack Bao, Hendrik Bessembinder (the editor), Phil Davies, Darrell Duffie, Kewei Hou, Andrew Karolyi, Rose Liao, Bernadette Minton, Taylor Nadauld, Alex Philipov, Tim Scholl, Ken Singleton, René Stulz, Jennifer Sustersic, Jérôme Taillard, and Scott Yonker. I thank seminar participants at Ohio State University, the U.S. Securities and Exchange Commission, Dimensional Fund Advisors, the University of New South Wales, the Federal Reserve Board, George Mason University, and George Washington University. I also thank the Dice Center for research support.

Footnotes

References

Hide All
Acharya, V., and Johnson, T. C.. “Insider Trading in Credit Derivatives.” Journal of Financial Economics, 84 (2007), 110141.
Acharya, V.; Schaefer, S.; and Zhang, Y.. “Liquidity Risk and Correlation Risk: A Clinical Study of the General Motors and Ford Downgrade of May 2005.” Quarterly Journal of Finance, 5 (2015), 151.
Adrian, T.; Etula, E.; and Muir, T.. “Financial Intermediaries and the Cross-Section of Asset Returns.” Journal of Finance, 69 (2013), 15406261.
Adrian, T., and Fleming, M.. “What Financing Data Reveal about Dealer Leverage.” Current Issues in Economics and Finance, 11 (2005).
Aitkin, M.Correlation in a Singly Truncated Bivariate Normal Distribution.” Psychometrika, 29 (1964), 263270.
Allen, L., and Saunders, A.. “A Survey of Cyclical Effects in Credit Risk Measurement Models.” Working Paper, Bank of International Settlement (2003).
Arora, N.; Gandhi, P.; and Longstaff, F. A.. “Counterparty Credit Risk and the Credit Default Swap Market.” Journal of Financial Economics, 103 (2012), 280293.
Azizpour, S.; Giesecke, K.; and Kim, B.. “Premia for Correlated Default Risk.” Journal of Economic Dynamics and Control, 35 (2011), 13401357.
Baker, M., and Wurgler, J.. “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 132.
Bao, J., and Pan, J.. “Bond Illiquidity and Excess Volatility.” Review of Financial Studies, 26 (2013), 30683103.
Bekaert, G.; Harvey, C.; and Ng, A.. “Market Integration and Contagion.” Journal of Business, 78 (2005), 3969.
Bekaert, G.; Hodrick, R. J.; and Zhang, X.. “International Stock Return Comovements.” Journal of Finance, 64 (2009), 25912626.
Ben-David, I.; Franzoni, F.; and Moussawi, R.. “Hedge Fund Stock Trading in the Financial Crisis of 2007–2009.” Review of Financial Studies, 25 (2012), 154.
Berndt, A.; Douglas, R.; Duffie, J. D.; Ferguson, M.; and Schranz, D.. “Measuring Default Risk Premia from Default Swap Rates and EDFs.” Working Paper, Bank of International Settlement (2008).
Blanco, R.; Brennan, S.; and Marsh, I.. “An Empirical Analysis of the Dynamic Relation between Investment-Grade Bonds and Credit Default Swaps.” Journal of Finance, 60 (2005), 22552281.
Bongaerts, D.; de Jong, F.; and Driessen, J.. “Derivative Pricing with Liquidity Risk: Theory and Evidence from the Credit Default Swap Market.” Journal of Finance, 66 (2011), 203240.
Brunnermeier, M. K.Deciphering the Liquidity and Credit Crunch 2007–2008.” Journal of Economic Perspectives, 23 (2009), 77100.
Brunnermeier, M. K., and Pedersen, L. H.. “Market Liquidity and Funding Liquidity.” Review of Financial Studies, 22 (2009), 22012238.
Campbell, J. Y.; Hilscher, J.; and Szilagyi, J.. “In Search of Distress Risk.” Journal of Finance, 63 (2008), 28992939.
Campbell, J. Y., and Taksler, G. B.. “Equity Volatility and Corporate Bond Yields.” Journal of Finance, 58 (2003), 23212349.
Casey, O., and Price, T.. “The CDS Big Bang: Understanding the Changes to the Global CDS Contract and North American Conventions.” Markit Research Report (2009).
Chen, L.; Lesmond, D. A.; and Wei, J.. “Corporate Yield Spreads and Bond Liquidity.” Journal of Finance, 62 (2007), 119149.
Christoffersen, P.; Jacobs, K.; Jin, X.; and Langlois, H.. “Dynamic Dependence in Corporate Credit.” Working Paper, University of Toronto (2016).
Collin-Dufresne, P.; Goldstein, R.; and Martin, S.. “The Determinants of Credit Spread Changes.” Journal of Finance, 56 (2001), 21772207.
Crosbie, P., and Bohn, J.. “Modeling Default Risk.” Moody’s KMV Report (2003).
Donner, A., and Zou, G.. “Testing the Equality of Dependent Intraclass Correlation Coefficients.” Journal of the Royal Statistical Society Series D: The Statistician, 51 (2002), 367379.
Driessen, J.Is Default Event Risk Priced in Corporate Bonds?Review of Financial Studies, 18 (2005), 165195.
Duffie, D.“Innovations in Credit Risk Transfer: Implications for Financial Stability.” Working Paper, Bank of International Settlement (2008).
Duffie, D.; Eckner, A.; Horel, G.; and Saita, L.. “Frailty Correlated Default.” Journal of Finance, 64 (2009), 20892123.
Eichengreen, B.; Mody, A.; Nedeljkovic, M.; and Sarno, L.. “How the Subprime Crisis Went Global: Evidence from Bank Credit Default Swap Spreads.” Journal of International Money and Finance, 31 (2012), 12991318.
Elton, E.; Gruber, M.; Agrawal, D.; and Mann, C.. “Explaining the Rate Spread on Corporate Bonds.” Journal of Finance, 56 (2001), 247277.
Ericsson, J.; Jacobs, K.; and Oviedo, R.. “The Determinants of Credit Default Swap Premia.” Journal of Financial and Quantitative Analysis, 44 (2009), 109132.
Fama, E., and French, K.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427465.
Fama, E., and French, K.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 356.
Ferson, W. E., and Harvey, C. R.. “The Variation of Economic Risk Premiums.” Journal of Political Economy, 99 (1991), 385415.
Fleming, M.Measuring Treasury Market Liquidity.” Federal Reserve Bank of New York Economic Policy Review, 9 (2003), 83108.
Frazzini, A., and Pedersen, L. H.. “Betting against Beta.” Journal of Financial Economics, 111 (2013), 125.
Gilchrist, S., and Zakrajsek, E.. “Credit Spreads and Business Cycle Fluctuations.” American Economic Review, 102 (2012), 16921720.
He, Z., and Krishnamurthy, A.. “A Model of Capital and Crises.” Review of Economic Studies, 79 (2012), 735777.
Jarrow, R.; Lando, D.; and Yu, F.. “Default Risk and Diversification: Theory and Empirical Implications.” Mathematical Finance, 15 (2005), 126.
Jorion, P., and Zhang, G.. “Good and Bad Credit Contagion: Evidence from Credit Default Swaps.” Journal of Financial Economics, 84 (2007), 860883.
Jorion, P., and Zhang, G.. “Credit Contagion from Counterparty Risk.” Journal of Finance, 64 (2009), 20532087.
Kallberg, J., and Pasquariello, P.. “Time-Series and Cross-Sectional Excess Comovement in Stock Indexes.” Journal of Empirical Finance, 15 (2008), 481502.
Kandel, S., and Stambaugh, R. F.. “On the Predictability of Stock Returns: An Asset-Allocation Perspective.” Journal of Finance, 51 (1996), 385424.
Kealhofer, S.Quantifying Credit Risk I: Default Prediction.” Financial Analysts Journal, 59 (2003), 3044.
Kim, D. H.; Loretan, M.; and Remolona, E. M.. “Contagion and Risk Premia in the Amplification of Crisis: Evidence from Asian Names in the Global CDS Market.” Journal of Asian Economics, 21 (2010), 314326.
Liu, J.; Longstaff, F. A.; and Mandell, R. E.. “The Market Price of Risk in Interest Rate Swaps: The Roles of Default and Liquidity Risks.” Journal of Business, 79 (2006), 23372359.
Longstaff, F. A.The Subprime Credit Crisis and Contagion in Financial Markets.” Journal of Financial Economics, 97 (2010), 436450.
Merton, R. C.On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449470.
Mitchell, M.; Pedersen, L. H.; and Pulvino, T.. “Slow-Moving Capital.” American Economic Review, 97 (2007), 215220.
Mitchell, M., and Pulvino, T.. “Arbitrage Crashes and the Speed of Capital.” Journal of Financial Economics, 104 (2012), 469490.
Morck, R.; Yeung, B.; and Yu, W.. “The Information Content of Stock Markets: Why Do Emerging Markets Have Synchronous Stock Price Movements?Journal of Financial Economics, 58 (2000), 215260.
Pástor, V., and Stambaugh, R.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642685.
Pu, X.Liquidity Commonality across the Bond and CDS Markets.” Journal of Fixed Income, 19 (2009), 2639.
Pu, X., and Zhao, X.. “Correlation in Credit Risk Changes.” Journal of Banking and Finance, 36 (2012), 10931106.
Schaefer, S. M., and Strebulaev, I. A.. “Structural Models of Credit Risk Are Useful: Evidence from Hedge Ratios on Corporate Bonds.” Journal of Financial Economics, 90 (2008), 119.
Schucany, W. R., and Frawley, W. H.. “A Rank Test for Two-Group Concordance.” Psychometrika, 38 (1973), 249258.
Stanton, R., and Wallace, N.. “The Bear’s Lair: Index Credit Default Swaps and the Subprime Mortgage Crisis.” Review of Financial Studies, 24 (2011), 32503280.
Tang, D., and Yan, H.. “Liquidity and Credit Default Swap Spreads.” Working Paper, University of Hong Kong (2008).
Vassalou, M., and Xing, Y.. “Default Risk in Equity Returns.” Journal of Finance, 59 (2004), 831868.

Related content

Powered by UNSILO

What Drives the Commonality between Credit Default Swap Spread Changes?

  • Mike Anderson

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed.