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An Empirical Investigation in Credit Spread Indices

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Author Info

  • Prigent, J.-L.

    (Université de Cergy-Pontoise, THEMA)

  • Renault, O.

    (London School of Economics, Financial Markets Group)

  • Scaillet, O.

    (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES); UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut d’Administration et de Gestion (IAG))

Abstract

We study the dynamics of the spread between U.S. corporate and Treasury bonds. We focus on Aaa and Baa corporate yield indices and estimate nonparametrically the dynamics of the spreads assuming that they follow a univariate diffusion process. Using techniques developed for interest rate processes we try to infer from the data what acceptable process can be used to model aggregate credit spreads for option pricing or risk management purposes. We find that there is significant evidence of mean reversion especially for higher rated spreads and that the volatility of Aaa spreads exhibit a U-shape while the volatility of Baa spreads is monotonically increasing in the level of spreads. Based on these observations and on the evidence of jumps in the series, we propose a new model for credit spread indices (an Ornstein-Uhlenbeck with jumps) and estimate it by maximum likelihood.

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Bibliographic Info

Paper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2000028.

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Length: 32
Date of creation: 01 Sep 2000
Date of revision:
Handle: RePEc:ctl:louvir:2000028

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Keywords: Credit spread; risk management; jump diffusion; volatility; nonparametric;

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Cited by:
  1. Carl Chiarella & Christina Nikitopoulos Sklibosios & Erik Schlögl, 2007. "A Markovian Defaultable Term Structure Model With State Dependent Volatilities," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., World Scientific Publishing Co. Pte. Ltd., vol. 10(01), pages 155-202.
  2. Roger WALDER, 2002. "Interactions Between Market and Credit Risk: Modeling the Joint Dynamics of Default-Free and Defaultable Bond Term Structures," FAME Research Paper Series, International Center for Financial Asset Management and Engineering rp56, International Center for Financial Asset Management and Engineering.
  3. Christina Nikitopoulos-Sklibosios, 2005. "A Class of Markovian Models for the Term Structure of Interest Rates Under Jump-Diffusions," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 6.

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