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Dependence structure between the credit default swap return and the kurtosis of the equity return distribution: Evidence from Japan

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  • Chen, Yi-Hsuan
  • Tu, Anthony H.
  • Wang, Kehluh
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    Abstract

    We examine the dependence structure between the credit default swap (CDS) return and the kurtosis of the corresponding equity return distribution using copula functions to specify its nonnormal and nonlinear relationship. Three candidates, the Gaussian, the Student's t, and the Gumbel copulas, are compared. Daily CDS rates of 46 reference entities are collected from the Tokyo International Financial Exchange covering the period from April 2004 to June 2005. Our empirical results suggest that in lower rating classes, the Gumbel copula is the best fitting model, followed by the Student's t. The dependence structure is positive and asymmetric. To compensate for the higher risk, possibly incurred by more jumps, protection sellers demand higher CDS returns. Meanwhile, the upper tail dependence becomes significant as jump events and CDS returns increase simultaneously. Finally, CDS returns in lower rating classes are more sensitive to jump risk than those in the higher ratings.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of International Financial Markets, Institutions and Money.

    Volume (Year): 18 (2008)
    Issue (Month): 3 (July)
    Pages: 259-271

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    Handle: RePEc:eee:intfin:v:18:y:2008:i:3:p:259-271

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    Web page: http://www.elsevier.com/locate/intfin

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    1. Benjamin Yibin Zhang & Hao Zhou & Haibin Zhu, 2009. "Explaining Credit Default Swap Spreads with the Equity Volatility and Jump Risks of Individual Firms," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5099-5131, December.
    2. Fang, Hong-Bin & Fang, Kai-Tai & Kotz, Samuel, 2002. "The Meta-elliptical Distributions with Given Marginals," Journal of Multivariate Analysis, Elsevier, vol. 82(1), pages 1-16, July.
    3. Bates, David S, 1996. "Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 69-107.
    4. Fran├žois Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, 04.
    5. Zhou, Chunsheng, 2001. "The term structure of credit spreads with jump risk," Journal of Banking & Finance, Elsevier, vol. 25(11), pages 2015-2040, November.
    6. Fathi Abid & Nader Naifar, 2005. "The Impact Of Stock Returns Volatility On Credit Default Swap Rates: A Copula Study," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(08), pages 1135-1155.
    7. Marco Bee, 2004. "Modelling credit default swap spreads by means of normal mixtures and copulas," Applied Mathematical Finance, Taylor & Francis Journals, vol. 11(2), pages 125-146.
    8. Haibin Zhu & Benjamin Yibin Zhang & Hao Zhou, 2005. "Explaining credit default swap spreads with equity volatility and jump risks of individual firms," BIS Working Papers 181, Bank for International Settlements.
    9. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
    10. Haibin Zhu, 2006. "An Empirical Comparison of Credit Spreads between the Bond Market and the Credit Default Swap Market," Journal of Financial Services Research, Springer, vol. 29(3), pages 211-235, June.
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    Cited by:
    1. Naifar, Nader, 2012. "Modeling the dependence structure between default risk premium, equity return volatility and the jump risk: Evidence from a financial crisis," Economic Modelling, Elsevier, vol. 29(2), pages 119-131.

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