The determinants of CDS spreads

Abstract

This study proposes models that can be used as shorthand analysis tools for CDS spreads and CDS spread changes. For this purpose we examine the determinants of CDS spreads and spread changes on a broad database of 718 US firms during the period from early 2002 to early 2013. Contrary to previous studies, we discover that market variables still have explanatory power after controlling for firm-specific variables inspired by structural models. Three explanatory variables appear to overshadow the other variables examined in this paper: Stock Return, ∆Volatility (the change in stock return volatility) and ∆MRI (change in the median CDS spread in the rating class). We also discover that models used in the event study literature to explain spread changes can be improved by using additional market variables. Further, we show that ratings explain cross-section variation in CDS spreads even after controlling for structural model variables.

Determinants of Credit Default Swap Spreads: A Four-Market Panel Data Analysis

“…In contrast to Collin-Dufresne et al (2001) and Galil et al (2014), who investigate only CDS spread changes, in the eight equations that we test in this paper, we use two dependent variables, namely, CDS spread levels and changes, and 17 explanatory variables (level and change): three firm performance measures (ROA, ROE, and Tobin's Q); two economic indicators (GDP growth and GDP volatility); two stock market indicators (stock market returns and volatility); one interest rate (the 5-year swap rate); a financial crisis dummy; and an AR(1) error term. In this paper, all changes in explanatory variables are measured by using the formula ΔX i = X t -X t-1 .…”

“…Hypothesis One (H1) entails the testing of firm-specific factors in the CDS determination. Previous studies such as Ericsson et al (2009) and Galil et al (2014) include one firm performance related variable -leverage, in their work, our paper extends the investigation by introducing three firm performance variables. This approach adds further vigorousness to the CDS research, and it forms a major contribution of this paper to the understanding of CDS determinants.…”

“…Some key researchers who have contributed to the development of such models include Lando (1994Lando ( , 1998 Galil et al (2014). The underlying assumption of reduced-form models is rather different from that of structural models, in that the former treat default as an exogenously determined random shock, and as such, firm-specific factors or indeed any variables that could affect firm performance contain no information on the firm's default probability.…”

Credit Risk Calibration Based on CDS Spreads

“…A rise suggests a high default premium and therefore implies an increase in market risk. In accordance with Galil et al (2013) daily equity market returns (CRSP) as determinant of CDS spreads is also included in addition to daily real estate sector excess return over the market return.…”

“…It is also obvious to assume that stock return and credit spread expose a negative relationship. Refer to Galil et al (2013) change in leverage is not statistically significant as a determinant for CDS spread and is therefore excluded from the set of explanatory variables. However, as change in leverage is highly correlated with stock return this factor is considered through equity return to a certain extent.…”