Skip Navigation



RFS Advance Access published online on March 19, 2009
Review of Financial Studies, doi:10.1093/rfs/hhp004
This Article
Right arrow Full Text
Right arrow Full Text (Accepted Manuscript)
Right arrow All Versions of this Article:
22/12/5099    most recent
hhp004v1
Right arrow Alert me when this article is cited
Right arrow Alert me if a correction is posted
Services
Right arrow Email this article to a friend
Right arrow Similar articles in this journal
Right arrow Alert me to new issues of the journal
Right arrow Add to My Personal Archive
Right arrow Download to citation manager
Right arrowRequest Permissions
Google Scholar
Right arrow Articles by Zhang, B. Y.
Right arrow Articles by Zhu, H.
Right arrow Search for Related Content
Social Bookmarking
Add to CiteULike   Add to Connotea   Add to Del.icio.us  
What's this?

© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Explaining Credit Default Swap Spreads with the Equity Volatility and Jump Risks of Individual Firms

Benjamin Yibin Zhang
UBS-Global Credit Strategies

Hao Zhou
Federal Reserve Board

Haibin Zhu
Bank for International Settlements

Send correspondence to Hao Zhou, Federal Reserve Board, Mail Stop 91, Washington, DC 20551; telephone: 202-452-3360; fax: 202-728-5887. E-mail: hao.zhou{at}frb.gov.

JEL Classification: G12, G13, C14


  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.

The views presented here are solely those of the authors and do not necessarily represent those of UBS-Global Credit Strategies, the Federal Reserve Board, or the Bank for International Settlements. The comments and suggestions from Joel Hasbrouck (the editor) and an anonymous referee are greatly appreciated. We thank Jeffrey Amato, Ren-Raw Chen, Pierre Collin-Dufresne, Gregory Duffee, Darrell Duffie, Michael Gibson, Jean Helwege, Jingzhi Huang, Kenneth Singleton, George Tauchen, Kostas Tsatsaronis, Hong Yan, and the seminar participants at the Federal Reserve Board, FDIC Derivative Conference, Bank for International Settlement, ESWC London, C.R.E.D.I.T. Venice, Peking University, CICF Xi'an, AEA Meeting in Chicago, and Utah Winter Finance Conference for helpful discussions. We also thank Christopher Karlsten and Chris Greene, the Federal Reserve Board, for editing assistance.


Add to CiteULike CiteULike   Add to Connotea Connotea   Add to Del.icio.us Del.icio.us    What's this?




Disclaimer: Please note that abstracts for content published before 1996 were created through digital scanning and may therefore not exactly replicate the text of the original print issues. All efforts have been made to ensure accuracy, but the Publisher will not be held responsible for any remaining inaccuracies. If you require any further clarification, please contact our Customer Services Department.