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Dynamics of credit spread moments of European corporate bond indexes

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  • Alizadeh, Amir H.
  • Gabrielsen, Alexandros

Abstract

Traditional quantitative credit risk models assume that changes in credit spreads are normally distributed but empirical evidence shows that they are likely to be skewed, fat-tailed, and change behaviour over time. Not taking into account such characteristics can compromise calculation of loss probabilities, pricing of credit derivatives, and profitability of trading strategies. Therefore, the aim of this study is to investigate the dynamics of higher moments of changes in credit spreads of European corporate bond indexes using extensions of GARCH type models that allow for time-varying volatility, skewness and kurtosis of changes in credit spreads as well as a regime-switching GARCH model which allows for regime shifts in the volatility of changes in credit spreads. Performance evaluation methods are used to assess which model captures the dynamics of observed distribution of the changes in credit spreads, produces superior volatility forecasts and Value-at-Risk estimates, and yields profitable trading strategies. The results presented can have significant implications for risk management, trading activities, and pricing of credit derivatives.

Suggested Citation

  • Alizadeh, Amir H. & Gabrielsen, Alexandros, 2013. "Dynamics of credit spread moments of European corporate bond indexes," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 3125-3144.
    • Handle: RePEc:eee:jbfina:v:37:y:2013:i:8:p:3125-3144
    DOI: 10.1016/j.jbankfin.2013.02.030
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    Cited by:

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    2. Nicholas Apergis & Alexandros Gabrielsen & Lee Smales, 2016. "(Unusual) weather and stock returns—I am not in the mood for mood: further evidence from international markets," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 30(1), pages 63-94, February.
    3. Grundke, Peter & Kühn, André, 2020. "The impact of the Basel III liquidity ratios on banks: Evidence from a simulation study," The Quarterly Review of Economics and Finance, Elsevier, vol. 75(C), pages 167-190.
    4. Sylvia J. Soltyk & Felix Chan, 2023. "Modeling time‐varying higher‐order conditional moments: A survey," Journal of Economic Surveys, Wiley Blackwell, vol. 37(1), pages 33-57, February.
    5. León, Ángel & Ñíguez, Trino-Manuel, 2021. "The transformed Gram Charlier distribution: Parametric properties and financial risk applications," Journal of Empirical Finance, Elsevier, vol. 63(C), pages 323-349.
    6. Wang, Tianyi & Liang, Fang & Huang, Zhuo & Yan, Hong, 2022. "Do realized higher moments have information content? - VaR forecasting based on the realized GARCH-RSRK model," Economic Modelling, Elsevier, vol. 109(C).
    7. Orlando, Giuseppe & Bufalo, Michele, 2022. "Modelling bursts and chaos regularization in credit risk with a deterministic nonlinear model," Finance Research Letters, Elsevier, vol. 47(PA).
    8. Changqing Luo & Mengzhen Li & Zisheng Ouyang, 2016. "An empirical study on the correlation structure of credit spreads based on the dynamic and pair copula functions," China Finance Review International, Emerald Group Publishing Limited, vol. 6(3), pages 284-303, August.
    9. Ephraim Clark & Selima Baccar, 2018. "Modelling credit spreads with time volatility, skewness, and kurtosis," Annals of Operations Research, Springer, vol. 262(2), pages 431-461, March.

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    More about this item

    Keywords

    Credit spread; GARCH; Skewness; Kurtosis; Regime switching; VaR;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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