Credit default swap spreads and variance risk premia
We find that firm-level variance risk premium, estimated as the difference between option-implied and expected variances, has a prominent explanatory power for credit spreads in the presence of market- and firm-level risk control variables identified in the existing literature. Such a predictability complements that of the leading state variable--leverage ratio--and strengthens significantly with lower firm credit rating, longer credit contract maturity, and model-free implied variance. We provide further evidence that: (1) variance risk premium has a cleaner systematic component and Granger-causes implied and expected variances, (2) the cross-section of firms' variance risk premia seem to price the market variance risk correctly, and (3) a structural model with stochastic volatility can reproduce the predictability pattern of variance risk premia for credit spreads.
|Date of creation:||2011|
|Date of revision:|
|Contact details of provider:|| Postal: 20th Street and Constitution Avenue, NW, Washington, DC 20551|
Web page: http://www.federalreserve.gov/
More information through EDIRC
|Order Information:||Web: http://www.federalreserve.gov/pubs/feds/fedsorder.html|
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.:
- Cremers, Martijn & Driessen, Joost & Maenhout, Pascal & Weinbaum, David, 2008.
"Individual stock-option prices and credit spreads,"
Journal of Banking & Finance,
Elsevier, vol. 32(12), pages 2706-2715, December.
- Hao Zhou, 2010. "Variance risk premia, asset predictability puzzles, and macroeconomic uncertainty," Finance and Economics Discussion Series 2010-14, Board of Governors of the Federal Reserve System (U.S.).
- Roberto Blanco & Simon Brennan & Ian W. Marsh, 2004.
"An empirical analysis of the dynamic relationship between investment grade bonds and credit default swaps,"
0401, Banco de España;Working Papers Homepage.
- 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.
- 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 Y. 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.).
- Hui Chen, 2010.
"Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure,"
NBER Working Papers
16151, National Bureau of Economic Research, Inc.
- Hui Chen, 2010. "Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure," Journal of Finance, American Finance Association, vol. 65(6), pages 2171-2212, December.
- Tim Bollerslev & Tzuo Hao & George Tauchen, 2008.
"Expected Stock Returns and Variance Risk Premia,"
CREATES Research Papers
2008-48, Department of Economics and Business Economics, Aarhus University.
- Tim Bollerslev & Hao Zhou, 2006. "Expected stock returns and variance risk premia," Finance and Economics Discussion Series 2007-11, Board of Governors of the Federal Reserve System (U.S.).
- Tim Bollerslev & Hao Zhou, 2007. "Expected Stock Returns and Variance Risk Premia," CREATES Research Papers 2007-17, Department of Economics and Business Economics, Aarhus University.
- Ericsson, Jan & Jacobs, Kris & Oviedo-Helfenberger, Rodolfo, 2004.
"The Determinants of Credit Default Swap Premia,"
SIFR Research Report Series
32, Institute for Financial Research.
- Harjoat S. Bhamra & Lars-Alexander Kuehn & Ilya A. Strebulaev, 2010. "The Levered Equity Risk Premium and Credit Spreads: A Unified Framework," Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 645-703, February.
- Long Chen & Pierre Collin-Dufresne & Robert S. Goldstein, 2009. "On the Relation Between the Credit Spread Puzzle and the Equity Premium Puzzle," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3367-3409, September.
- Peter Carr & Liuren Wu, 2010. "Stock Options and Credit Default Swaps: A Joint Framework for Valuation and Estimation," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 8(4), pages 409-449, Fall.
- Peter Carr & Liuren Wu, 2004. "Variance Risk Premia," Finance 0409015, EconWPA.
When requesting a correction, please mention this item's handle: RePEc:fip:fedgfe:2011-02. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marlene Vikor)
If references are entirely missing, you can add them using this form.