Common Factors in Credit Defaults Swaps Markets

Abstract

We examine what are common factors that determine systematic credit risk and estimate and interpret the common risk factors. We also compare the contributions of common factors in explaining the changes of credit default swap (CDS) spreads during the pre-crisis, crisis and post-crisis period. Based on the testing result from the common principal components model, this study finds that the eigenstructures across the three subperiods are distinct and the determinants of risk factors differ from threesubperiods. Furthermore, we analyze the predictive ability of dynamics in CDS indices changes by dynamic factor models. JEL classification:C38; G32; E43

The Integration of Credit Default Swap Markets in the Pre and Post-Subprime Crisis in Common Stochastic Trends

“…During the outbreak of the crisis, the common factors seem to play a major role in the comovement of CDS markets. Chen and Härdle (2014) and Eichengreen et al (2009) investigate the influence of common factors by using the technique of principal component analysis.…”

“…Eichengreen et al (2012) and Chen and Härdle (2014) found that common factors play a major role during and after the crisis. They further found that the eigenstructures are distinct for the pre, during and post-crisis periods, and the essences of latent factors are distinctive in three sub-periods.…”