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A Spread-Return Mean-Reverting Model For Credit Spread Dynamics

Author

Listed:
  • BRENDAN O'DONOGHUE

    (Electrical Engineering Department, Stanford University, USA)

  • MATTHEW PEACOCK

    (White Oak Asset Management SA, Switzerland)

  • JACKY LEE

    (Quantitative Strategies, Investment Banking Division, Credit Suisse Group, United Kingdom)

  • LUCA CAPRIOTTI

    (Quantitative Strategies, Investment Banking Division, Credit Suisse Group, United Kingdom)

Abstract

In this paper, we propose a novel, analytically tractable, one-factor stochastic model for the dynamics of credit default swap (CDS) spreads and their returns, which we refer to as the spread-return mean-reverting (SRMR) model. The SRMR model can be seen as a hybrid of the Black–Karasinski model on spreads and the Ornstein–Uhlenbeck model on spread returns, and is able to capture empirically observed properties of CDS spreads and returns, including spread mean-reversion, heavy tails of the return distribution, and return autocorrelations. Although developed for modeling CDS spreads, the SRMR model has applications for many other stochastic processes with similar empirical properties, including more general rate processes.

Suggested Citation

  • Brendan O'Donoghue & Matthew Peacock & Jacky Lee & Luca Capriotti, 2014. "A Spread-Return Mean-Reverting Model For Credit Spread Dynamics," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 17(03), pages 1-14.
    • Handle: RePEc:wsi:ijtafx:v:17:y:2014:i:03:n:s0219024914500174
    DOI: 10.1142/S0219024914500174
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    Citations

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    Cited by:

    1. Consiglio, Andrea & Zenios, Stavros A., 2015. "The Case for Contingent Convertible Debt for Sovereignst," Working Papers 15-13, University of Pennsylvania, Wharton School, Weiss Center.
    2. Mili, Mehdi, 2019. "The impact of tradeoff between risk and return on mean reversion in sovereign CDS markets," Research in International Business and Finance, Elsevier, vol. 48(C), pages 187-200.
    3. Andrea Consiglio & Michele Tumminello & Stavros A. Zenios, 2018. "Pricing Sovereign Contingent Convertible Debt," Journal of Enterprising Culture (JEC), World Scientific Publishing Co. Pte. Ltd., vol. 21(08), pages 1-36, December.
    4. Consiglio Andrea & Zenios Stavros A., 2018. "Contingent Convertible Bonds for Sovereign Debt Risk Management," Journal of Globalization and Development, De Gruyter, vol. 9(1), pages 1-24, June.

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