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An Empirical Investigation in Credit Spread Indices

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  • Olivier Scaillet
  • Olivier Renault
  • Jean-Luc Prigent

Abstract

We study the dynamics of the spread between US 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 technique 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-Uhlenback with jumps) and estimate it by maximum likelihood

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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp363.

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Date of creation: Nov 2000
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Handle: RePEc:fmg:fmgdps:dp363

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Web page: http://www.lse.ac.uk/fmg/

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Cited by:
  1. Carl Chiarella & Erik Schlögl & Christina Nikitopoulos-Sklibosios, 2004. "A Markovian Defaultable Term Structure Model with State Dependent Volatilities," Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney 135, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. 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, number 6, June.
  3. 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.

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