US Corporate Default Swap Valuation: The Market Liquidity Hypothesis and Autonomous Credit Risk
This paper develops a reduced form three-factor model which includes a liquidity proxy of market conditions which is then used to provide implicit prices. The model prices are then compared with observed market prices of credit default swaps to determine if swap rates adequately reflect market risks. The findings of the analysis illustrate the importance of liquidity in the valuation process. Moreover, market liquidity, a measure of investors. willingness to commit resources in the credit default swap (CDS) market, was also found to improve the valuation of investors. autonomous credit risk. Thus a failure to include a liquidity proxy could underestimate the implied autonomous credit risk. Autonomous credit risk is defined as the fractional credit risk which does not vary with changes in market risk and liquidity conditions.
|Date of creation:||Jan 2007|
|Publication status:||Forthcoming in The Journal of Quantitative Finance|
|Note:||This is a preprint of an article submitted for consideration in the Journal of Quantitative finance 2007; cc Taylor and Francis; The Journal of Quantitative Finance is available online at http://journalsonline.tandf.co.uk/|
|Contact details of provider:|| Postal: University of Connecticut 365 Fairfield Way, Unit 1063 Storrs, CT 06269-1063|
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
More information through EDIRC
References listed on IDEAS
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.:
- Heath, David & Jarrow, Robert & Morton, Andrew, 1992.
"Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation,"
Econometric Society, vol. 60(1), pages 77-105, January.
- David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305 World Scientific Publishing Co. Pte. Ltd..
- Liuren Wu & Frank X. Zhang, 2005. "A no-arbitrage analysis of economic determinants of the credit spread term structure," Finance and Economics Discussion Series 2005-59, Board of Governors of the Federal Reserve System (U.S.).
- Madan, Dilip & Unal, Haluk, 2000.
"A Two-Factor Hazard Rate Model for Pricing Risky Debt and the Term Structure of Credit Spreads,"
Journal of Financial and Quantitative Analysis,
Cambridge University Press, vol. 35(01), pages 43-65, March.
- Dilip Madan & Haluk Unal, 1999. "A Two-Factor Hazard-Rate Model for Pricing Risky Debt and the Term Structure of Credit Spreads," Center for Financial Institutions Working Papers 99-32, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Sanjiv Ranjan Das & Rangarajan K. Sundaram, 1998. "A Direct Approach to Arbitrage-Free Pricing of Derivatives," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-013, New York University, Leonard N. Stern School of Business-.
- Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
- Acharya, Viral V. & Johnson, Timothy C., 2007.
"Insider trading in credit derivatives,"
Journal of Financial Economics,
Elsevier, vol. 84(1), pages 110-141, April.
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
- 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.
- Robert A. Jarrow & Stuart M. Turnbull, 2008.
"Pricing Derivatives on Financial Securities Subject to Credit Risk,"
World Scientific Book Chapters,
in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409
World Scientific Publishing Co. Pte. Ltd..
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
- Jarrow, Robert A. & Turnbull, Stuart M., 2000. "The intersection of market and credit risk," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 271-299, January.
- Houweling, P. & Vorst, A.C.F., 2003.
"Pricing default swaps: empirical evidence,"
Econometric Institute Research Papers
EI 2003-51, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
- 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.).
- Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008.
"A Markov Model for the Term Structure of Credit Risk Spreads,"
World Scientific Book Chapters,
in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453
World Scientific Publishing Co. Pte. Ltd..
- Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
- Michael J. Fleming, 2001.
"Measuring treasury market liquidity,"
133, Federal Reserve Bank of New York.
- Duffie, Darrell & Singleton, Kenneth J, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September.
- Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
- Sanjiv R. Das & Rangarajan K. Sundaram, 1998. "A Direct Approach to Arbitrage-Free Pricing of Credit Derivatives," NBER Working Papers 6635, National Bureau of Economic Research, Inc.
- Long Chen & David A. Lesmond & Jason Wei, 2007. "Corporate Yield Spreads and Bond Liquidity," Journal of Finance, American Finance Association, vol. 62(1), pages 119-149, 02.
When requesting a correction, please mention this item's handle: RePEc:uct:uconnp:2007-08. 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: (Mark McConnel)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.