The Information Content of Option-Implied Volatility for Credit Default Swap Valuation

Cao, Charles; Zhong, Zhaodong; Yu, Fan

doi:10.2139/ssrn.889867

Cited by 87 publications

(96 citation statements)

References 35 publications

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“…In general, the evidence for S&P and Fitch supports the view that changes in option-implied volatility help explain changes in creditworthiness of underlying entities which is, to some extent, consistent with prior papers (e.g. Collin-Dufresne et al, 2001;Cao et al, 2010). 21 There is no significant evidence of the causality or lead-lag relationship between ∆IV and Moody's actions, even for lags up to 3 months.…”

Section: Lead-lag Relationship Between Implied Volatility and Credit supporting

confidence: 82%

Sovereign rating actions and the implied volatility of stock index options

Tran

Alsakka

Gwilym

2014

International Review of Financial Analysis

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This paper examines the interaction between the equity index option market and sovereign credit ratings. S&P and Moody's signals exhibit strong impact on option-implied volatility while Fitch's influence is less significant. Moody's downgrades reduce the market uncertainty over the rated countries' equity markets. Strong causal relationships are found between movements in the option-implied volatility and all credit signals released by S&P and Fitch, but only actual rating changes by Moody's, implying differences in rating agencies' policies. The presence of additional ratings tends to reduce market uncertainty. The findings highlight the importance of rating information in the price discovery process and offer policy implications. JEL classification: G14; G15; G24

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Section: Lead-lag Relationship Between Implied Volatility and Credit supporting

confidence: 82%

Sovereign rating actions and the implied volatility of stock index options

Tran

Alsakka

Gwilym

2014

International Review of Financial Analysis

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“…The results produced model implied CDS spreads that closely matched the actual traded 5-year CDS. Other studies [12][13][14] have subsequently been published which agree with the findings in [10] across a broad cross section of credits.…”

Section: Introductionsupporting

confidence: 67%

Capital Structure Arbitrage under a Risk Neutral Calibration

Zeitsch¹

2016

Preprint

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By reinterpreting the calibration of structural models, a reassessment of the importance of the input variables is undertaken. The analysis shows that volatility is the key parameter to any calibration exercise by several orders of magnitude. In order to maximize the sensitivity to volatility, a simple formulation of Merton's model is proposed that employs deep out-of-the-money option implied volatilities. The methodology also eliminates the use of historic data to specify the default barrier thereby leading to a full risk neutral calibration. Subsequently, a new technique for identifying and hedging capital structure arbitrage opportunities is illustrated. The approach seeks to hedge the volatility risk, or vega, as opposed to the exposure from the underlying equity itself, or delta. The results question the efficacy of the common arbitrage strategy of only executing the delta hedge.

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“…There are investors who price bond risk in with movement in CDS spreads in analogue to those who price in equity risk with VIX. Moreover, Cao et al (2010) show that the volatility risk premium embedded in option prices covaries with the CDS spread. Galil et al (2014) show that change in VIX has a significant explanatory power of changes in CDS spreads in the absence of market factors.…”

Section: Shock Variablesmentioning

confidence: 96%

Linkages between financial sector CDS spreads and macroeconomic influence in a nonlinear setting

Lahiani

Hammoudeh

Gupta

2016

International Review of Economics & Finance

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Highlights• The paper examines asymmetric and nonlinear transmissions for sector CDS spreads.• The model is NARDL and CDSs are for bank, financial service and insurance sectors.• The influences come from the financial, equity risk and energy price factors.• There is evidence of short-and long-run nonlinearities and asymmetries for the CDSs.• There are also short-and long-run asymmetries in the economic and risk influences. Abstract:This paper investigates the asymmetric and nonlinear transmission of financial and energy prices to US five-year financial CDS sector index spreads for the banking, financial services and insurance sectors in the short-and long-run over the recent periods revolving around the global financial crisis. We employ the nonlinear ARDL (NARDL) model to account for the short-and long-run asymmetries in the sensitivity of those CDS sector index spreads to their determinants. Our findings suggest that there is evidence of short-and long-run nonlinearities and asymmetries in the adjustment process of the three CDS variables. There are also shortand long-run asymmetries in the influences of macroeconomic and financial variables on the CDS sector spreads. These findings are important for policymakers who deal with credit risks at the sector levels.JEL Codes: C32, F65, G01

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The Information Content of Option-Implied Volatility for Credit Default Swap Valuation

Cited by 87 publications

References 35 publications

Sovereign rating actions and the implied volatility of stock index options

Sovereign rating actions and the implied volatility of stock index options

Capital Structure Arbitrage under a Risk Neutral Calibration

Linkages between financial sector CDS spreads and macroeconomic influence in a nonlinear setting

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