Information_content_of_CDS_implied_volatility_and_associated_trading_strategies__mytitlenote (2).pdf (1.51 MB)
The information content of CDS implied volatility and associated trading strategies
journal contribution
posted on 2023-06-10, 06:41 authored by Yukun Shi, Ding Chen, Biao Guo, Yaofei Xu, Cheng YanUsing the theoretical link between put options and credit default swaps (CDS) in a very general setting, we develop a robust measure of CDS implied volatility (CIV) that captures the information content of CDS markets. Specifically, we use the unit recovery claim to bridge CDS and deep out-of-the-money put options of the same firm and then back out CIV via the binomial tree. Our CIV measure strongly co-moves with the option implied volatility (OIV), with a correlation coefficient of 0.8. Based on the standardized difference between CIV and OIV, we construct CDS and option trading strategies. Without taking transaction costs into account, the long–short CDS trading strategy achieves an annualized return of 58.29% and a Sharpe ratio of 2.97, which cannot be explained by non-parametric skewness and volatility risk.
History
Publication status
- Published
File Version
- Accepted version
Journal
International Review of Financial AnalysisISSN
1057-5219Publisher
ElsevierExternal DOI
Volume
83Page range
102295-102295Department affiliated with
- Accounting and Finance Publications
Full text available
- No
Peer reviewed?
- Yes
Legacy Posted Date
2023-04-12First Compliant Deposit (FCD) Date
2023-04-04Usage metrics
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