US corporate default swap valuation: the market liquidity hypothesis and autonomous credit risk
AbstractThis paper develops a reduced form three-factor model which includes a liquidity proxy of market conditions which is then used to provide implicit prices. The model prices are then compared with observed market prices of credit default swaps to determine if swap rates adequately reflect market risks. The findings of the analysis illustrate the importance of liquidity in the valuation process. Moreover, market liquidity, a measure of investors' willingness to commit resources in the credit default swap (CDS) market, was also found to improve the valuation of investors' autonomous credit risk. Thus a failure to include a liquidity proxy could underestimate the implied autonomous credit risk. Autonomous credit risk is defined as the fractional credit risk which does not vary with changes in market risk and liquidity conditions.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Quantitative Finance.
Volume (Year): 8 (2008)
Issue (Month): 3 ()
Contact details of provider:
Web page: http://www.tandfonline.com/RQUF20
Other versions of this item:
- Kwamie Dunbar, 2007. "US Corporate Default Swap Valuation: The Market Liquidity Hypothesis and Autonomous Credit Risk," Working papers 2007-08, University of Connecticut, Department of Economics.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Houweling, Patrick & Vorst, Ton, 2005.
"Pricing default swaps: Empirical evidence,"
Journal of International Money and Finance,
Elsevier, vol. 24(8), pages 1200-1225, December.
- Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
- Acharya, Viral V & Johnson, Tim, 2005.
"Insider Trading in Credit Derivatives,"
CEPR Discussion Papers
5180, C.E.P.R. Discussion Papers.
- Sanjiv Ranjan Das & Rangarajan K. Sundaram, 1998. "A Direct Approach to Arbitrage-Free Pricing of Derivatives," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-013, New York University, Leonard N. Stern School of Business-.
- Roberto Blanco & Simon Brennan & Ian W Marsh, 2004.
"An empirical analysis of the dynamic relationship between investment-grade bonds and credit default swaps,"
Bank of England working papers
211, Bank of England.
- Roberto Blanco & Simon Brennan & Ian W. Marsh, 2004. "An empirical analysis of the dynamic relationship between investment grade bonds and credit default swaps," Banco de Espaï¿½a Working Papers 0401, Banco de Espa�a.
- Sanjiv R. Das & Rangarajan K. Sundaram, 1998. "A Direct Approach to Arbitrage-Free Pricing of Credit Derivatives," NBER Working Papers 6635, National Bureau of Economic Research, Inc.
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
- Liuren Wu & Frank Xiaoling Zhang, 2005. "A no-arbitrage analysis of economic determinants of the credit spread term structure," Finance and Economics Discussion Series 2005-59, Board of Governors of the Federal Reserve System (U.S.).
- Michael J. Fleming, 2003.
"Measuring treasury market liquidity,"
Economic Policy Review,
Federal Reserve Bank of New York, issue Sep, pages 83-108.
- Long Chen & David A. Lesmond & Jason Wei, 2007. "Corporate Yield Spreads and Bond Liquidity," Journal of Finance, American Finance Association, vol. 62(1), pages 119-149, 02.
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
- Jarrow, Robert A. & Turnbull, Stuart M., 2000. "The intersection of market and credit risk," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 271-299, January.
- Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
- 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.
- Benjamin Yibin Zhang & Hao Zhou & Haibin Zhu, 2005. "Explaining credit default swap spreads with the equity volatility and jump risks of individual firms," Finance and Economics Discussion Series 2005-63, Board of Governors of the Federal Reserve System (U.S.).
- Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
- Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
- Duffie, Darrell & Singleton, Kenneth J, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September.
- Madan, Dilip & Unal, Haluk, 2000. "A Two-Factor Hazard Rate Model for Pricing Risky Debt and the Term Structure of Credit Spreads," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(01), pages 43-65, March.
- Kwamie Dunbar, 2009. "The Effects of Credit Risk on Dynamic Portfolio Management: A New Computational Approach," Working papers 2009-03, University of Connecticut, Department of Economics, revised Feb 2009.
- Bühler, Wolfgang & Trapp, Monika, 2009. "Time-varying credit risk and liquidity premia in bond and CDS markets," CFR Working Papers 09-13, University of Cologne, Centre for Financial Research (CFR).
- Michele Leonardo Bianchi, 2012. "An empirical comparison of alternative credit default swap pricing models," Temi di discussione (Economic working papers) 882, Bank of Italy, Economic Research and International Relations Area.
- Rösch, Christoph G. & Kaserer, Christoph, 2013. "Market liquidity in the financial crisis: The role of liquidity commonality and flight-to-quality," Journal of Banking & Finance, Elsevier, vol. 37(7), pages 2284-2302.
- Dunbar, Kwamie & Amin, Abu S., 2012. "Credit risk dynamics in response to changes in the federal funds target: The implication for firm short-term debt," Review of Financial Economics, Elsevier, vol. 21(3), pages 141-152.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michael McNulty).
If references are entirely missing, you can add them using this form.