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Credit-default swap rates and equity volatility: a nonlinear relationship

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Author Info

  • Fathi Abid
  • Nader Naifar
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    Abstract

    Purpose – The aim of this paper is to study the impact of equity returns volatility of reference entities on credit-default swap rates using a new dataset from the Japanese market. Design/methodology/approach – Using a copula approach, the paper models the different relationships that can exist in different ranges of behavior. It studies the bivariate distributions of credit-default swap rates and equity return volatility estimated with GARCH (1,1) and focus on one parameter Archimedean copula. Findings – First, the paper emphasizes the finding that pairs with higher rating present a weaker dependence coefficient and then, the impact of equity returns volatility on credit-default swap rates is higher for the lowest rating class. Second, the dependence structure is positive and asymmetric indicating that protection sellers ask for higher credit-default swap returns to compensate the higher credit risk incurred by low rating class. Practical implications – The paper has several practical implications that are of value for financial hedgers and engineers, loan market participants, financial regulators, government regulators, central banks, and risk managers. Originality/value – The paper also illustrates the potential benefits of equity returns volatility of reference entities as a proxy of default risk. These simplifications could be lifted in future research on this theme.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Journal of Risk Finance.

    Volume (Year): 7 (2006)
    Issue (Month): 4 (August)
    Pages: 348-371

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    Handle: RePEc:eme:jrfpps:v:7:y:2006:i:4:p:348-371

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    Web page: http://www.emeraldinsight.com

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    Postal: Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK
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    Web: http://www.emeraldinsight.com/jrf.htm

    Related research

    Keywords: Credit; Equity capital; Japan;

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    Cited by:
    1. Shawkat Hammoudeh & Tengdong Liu & Chia-Lin Chang & Michael McAleer, 2011. "Risk Spillovers in Oil-Related CDS, Stock and Credit Markets," Working Papers in Economics 11/17, University of Canterbury, Department of Economics and Finance.
    2. Naifar, Nader, 2011. "What explains default risk premium during the financial crisis? Evidence from Japan," Journal of Economics and Business, Elsevier, vol. 63(5), pages 412-430, September.
    3. 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.
    4. Ramaprasad Bhar, 2010. "Stochastic Filtering With Applications In Finance:," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 7736.
    5. Fathi, Abid & Nader, Naifar, 2007. "Copula based simulation procedures for pricing basket Credit Derivatives," MPRA Paper 6014, University Library of Munich, Germany.
    6. Hayette Gatfaoui, 2010. "Investigating the dependence structure between credit default swap spreads and the U.S. financial market," Annals of Finance, Springer, vol. 6(4), pages 511-535, October.
    7. Fathi, Abid & Nader, Naifar, 2007. "Price Calibration of basket default swap: Evidence from Japanese market," MPRA Paper 6013, University Library of Munich, Germany.
    8. Chen, Li-Hsueh & Hammoudeh, Shawkat & Yuan, Yuan, 2011. "Asymmetric convergence in US financial credit default swap sector index markets," The Quarterly Review of Economics and Finance, Elsevier, vol. 51(4), pages 408-418.

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