The surface of implied firm’s asset volatility

This paper analyzes the surface of CDS implied firm’s asset volatility at the aggregate market level, using a sample of European investment-grade firms during the 2007–2014 period. The term structure of asset implied volatilities is backed-out from the term structure of CDS spreads, while the moneyness dimension is proxied by the ratio of the default barrier to asset value. We find both a downward sloping term structure and a negative skew. Principal component analysis on the entire volatility surface shows that the first four components interpreted as a level, a term structure, a skew and a moneyness-related curvature mode capture 86% of the daily variation in asset implied volatility. We also find that the term structure slope is related to market and funding illiquidity, investors’ risk aversion, informational frictions, demand/supply factors and momentum.