Regime dependent determinants of credit default swap spreads

Alexander, Carol and Kaeck, Andreas (2008) Regime dependent determinants of credit default swap spreads. Journal of Banking & Finance, 32 (6). pp. 1008-1021. ISSN 0378-4266

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Abstract

Credit default swap (CDS) spreads display pronounced regime specific behaviour. A Markov switching model of the determinants of changes in the iTraxx Europe indices demonstrates that they are extremely sensitive to stock volatility during periods of CDS market turbulence. But in ordinary market circumstances CDS spreads are more sensitive to stock returns than they are to stock volatility. Equity hedge ratios are three or four times larger during the turbulent period, which explains why previous research on single-regime models finds stock positions to be ineffective hedges for default swaps. Interest rate movements do not affect the financial sector iTraxx indices and they only have a significant effect on the other indices when the spreads are not excessively volatile. Raising interest rates may decrease the probability of credit spreads entering a volatile period.

Item Type: Article
Keywords: iTraxx; Credit default swap; CDS; Credit spread; Hedging; Markov switching
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences > HG Finance
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Depositing User: Carol Alexander
Date Deposited: 11 Sep 2012 13:50
Last Modified: 09 Sep 2013 15:59
URI: http://sro.sussex.ac.uk/id/eprint/40612
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