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A value at risk analysis of credit default swaps

  • Scheicher, Martin
  • Raunig, Burkhard
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    We study the risk of holding credit default swaps (CDS) in the trading book. In particular, we compare the Value at Risk (VaR) of a CDS position to the VaR for investing in the respective firm's equity. Our sample consists of CDS – stock price pairs for 86 actively traded firms over the period from March 2003 to October 2006. We find that the VaR for a stock is usually far larger than the VaR for a position in the same firm's CDS. However, the distance between CDS VaR and equity VaR is markedly smaller for firms with high credit risk. The distance also declines for longer holding periods. We also observe a positive correlation between CDS and equity VaR.

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    Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2008,12.

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    Date of creation: 2008
    Date of revision:
    Handle: RePEc:zbw:bubdp2:7322
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    1. Acharya, Viral V & Johnson, Tim, 2005. "Insider Trading in Credit Derivatives," CEPR Discussion Papers 5180, C.E.P.R. Discussion Papers.
    2. Kwan, Simon H., 1996. "Firm-specific information and the correlation between individual stocks and bonds," Journal of Financial Economics, Elsevier, vol. 40(1), pages 63-80, January.
    3. Matthew Pritsker, 2001. "The hidden dangers of historical simulation," Finance and Economics Discussion Series 2001-27, Board of Governors of the Federal Reserve System (U.S.).
    4. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    5. Jan Ericsson & Kris Jacobs & Rodolfo A. Oviedo, 2004. "The Determinants of Credit Default Swap Premia," CIRANO Working Papers 2004s-55, CIRANO.
    6. Rosenberg, Joshua V. & Schuermann, Til, 2006. "A general approach to integrated risk management with skewed, fat-tailed risks," Journal of Financial Economics, Elsevier, vol. 79(3), pages 569-614, March.
    7. Jeffery D Amato & Eli M Remolona, 2003. "The credit spread puzzle," BIS Quarterly Review, Bank for International Settlements, December.
    8. Haibin Zhu & Benjamin Yibin Zhang & Hao Zhou, 2005. "Explaining credit default swap spreads with equity volatility and jump risks of individual firms," BIS Working Papers 181, Bank for International Settlements.
    9. Jing-zhi Huang & Hao Zhou, 2008. "Specification analysis of structural credit risk models," Finance and Economics Discussion Series 2008-55, Board of Governors of the Federal Reserve System (U.S.).
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