IDEAS home Printed from https://ideas.repec.org/p/zbw/ifwkwp/1946.html
   My bibliography  Save this paper

The role of a changing market environment for credit default swap pricing

Author

Listed:
  • Leppin, Julian S.
  • Reitz, Stefan

Abstract

This paper investigates the impact of a changing market environment on the pricing of CDS spreads written on debt from EURO STOXX 50 firms. A Panel Smooth Transition Regression reveals that parameter estimates of standard CDS fundamentals are time-varying depending on current values of a set of variables such as ECB's systemic stress composite index, the Sentix index for current and future economics situation, and the VStoxx. These variables describe the market's transition between different regimens thereby reflecting the impact of substantial swings in agents' risk perception on CDS spreads. Overall, our results confirm the importance of nonlinearities in the pricing of risk derivatives during tranquil and turbulent times.

Suggested Citation

  • Leppin, Julian S. & Reitz, Stefan, 2014. "The role of a changing market environment for credit default swap pricing," Kiel Working Papers 1946, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwkwp:1946
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/100077/1/791668568.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Hohenleitner, Ingrid & Hillmann, Katja, 2012. "Impact of Benefit Sanctions on Unemployment Outflow - Evidence from German Survey Data," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 66055, Verein für Socialpolitik / German Economic Association.
    2. Conconi, Paola & Facchini, Giovanni & Steinhardt, Max & Zanardi, Maurizio, 2012. "The political economy of trade and migration: Evidence from the U.S. Congress," CEPR Discussion Papers 9270, C.E.P.R. Discussion Papers.
    3. Alexander, Carol & Kaeck, Andreas, 2008. "Regime dependent determinants of credit default swap spreads," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 1008-1021, June.
    4. Andrés González & Timo Teräsvirta & Dick van Dijk & Yukai Yang, 1910. "Panel Smooth Transition Regression Models," CREATES Research Papers 2017-36, Department of Economics and Business Economics, Aarhus University.
    5. Hansen, Bruce E., 1999. "Threshold effects in non-dynamic panels: Estimation, testing, and inference," Journal of Econometrics, Elsevier, vol. 93(2), pages 345-368, December.
    6. Reich, Nora & Boll, Christina & Leppin, Julian Sebastian, 2012. "Fathers' childcare and parental leave policies: Evidence from Western European Countries and Canada," HWWI Research Papers 115, Hamburg Institute of International Economics (HWWI).
    7. Reich, Nora, 2012. "Fathers' childcare: The difference between participation and amount of time," HWWI Research Papers 116, Hamburg Institute of International Economics (HWWI).
    8. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
    9. Houweling, Patrick & Vorst, Ton, 2005. "Pricing default swaps: Empirical evidence," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1200-1225, December.
    10. Antonio Di Cesare & Giovanni Guazzarotti, 2010. "An analysis of the determinants of credit default swap spread changes before and during the subprime financial turmoil," Temi di discussione (Economic working papers) 749, Bank of Italy, Economic Research and International Relations Area.
    11. Ralf Becker & Denise R. Osborn, 2012. "Weighted Smooth Transition Regressions," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 27(5), pages 795-811, August.
    12. Galil, Koresh & Shapir, Offer Moshe & Amiram, Dan & Ben-Zion, Uri, 2014. "The determinants of CDS spreads," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 271-282.
    13. Nicholas Vause, 2010. "Counterparty risk and contract volumes in the credit default swap market," BIS Quarterly Review, Bank for International Settlements, December.
    14. Zierahn, Ulrich, 2012. "Monocentric cities, endogenous agglomeration, and unemployment disparities," HWWI Research Papers 130, Hamburg Institute of International Economics (HWWI).
    15. Arora, Navneet & Gandhi, Priyank & Longstaff, Francis A., 2012. "Counterparty credit risk and the credit default swap market," Journal of Financial Economics, Elsevier, vol. 103(2), pages 280-293.
    16. Ericsson, Jan & Jacobs, Kris & Oviedo, Rodolfo, 2009. "The Determinants of Credit Default Swap Premia," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(01), pages 109-132, February.
    17. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
    18. Berlemann, Michael & Enkelmann, Soeren & Kuhlenkasper, Torben, 2012. "Unraveling the complexity of US presidential approval: A multi-dimensional semi-parametric approach," HWWI Research Papers 118, Hamburg Institute of International Economics (HWWI).
    19. Kremer, Manfred & Lo Duca, Marco & Holló, Dániel, 2012. "CISS - a composite indicator of systemic stress in the financial system," Working Paper Series 1426, European Central Bank.
    20. Lay, Jann & Ondraczek, Janosch & Stoever, Jana, 2013. "Renewables in the energy transition: Evidence on solar home systems and lighting fuel choice in Kenya," Energy Economics, Elsevier, vol. 40(C), pages 350-359.
    21. Biermann, Franziska, 2012. "The impact of distance in seaborne trade: An analysis of bilateral container transport flows," HWWI Research Papers 134, Hamburg Institute of International Economics (HWWI).
    22. Skinner, Frank S. & Townend, Timothy G., 2002. "An empirical analysis of credit default swaps," International Review of Financial Analysis, Elsevier, vol. 11(3), pages 297-309.
    23. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    24. Cao, Charles & Yu, Fan & Zhong, Zhaodong, 2010. "The information content of option-implied volatility for credit default swap valuation," Journal of Financial Markets, Elsevier, vol. 13(3), pages 321-343, August.
    25. Kowalewski, Julia, 2012. "Inter-industrial relations and sectoral employment development in German regions," HWWI Research Papers 127, Hamburg Institute of International Economics (HWWI).
    26. Annaert, Jan & De Ceuster, Marc & Van Roy, Patrick & Vespro, Cristina, 2013. "What determines Euro area bank CDS spreads?," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 444-461.
    27. Kowalewski, Julia, 2012. "Regionalization of national input-output tables: Empirical evidence on the use of the FLQ formula," HWWI Research Papers 126, Hamburg Institute of International Economics (HWWI).
    28. repec:taf:edecon:v:24:y:2016:i:6:p:639-662 is not listed on IDEAS
    29. Friso Schlitte & Sven Schulze, 2014. "Siedlungsabfallaufkommen in Deutschland," Wirtschaftsdienst, Springer;German National Library of Economics, vol. 94(9), pages 680-682, September.
    30. Frei, Xenia & Kowalewski, Julia, 2013. "Sektorale und regionale Betroffenheit durch den Klimawandel am Beispiel der Metropolregion Hamburg," HWWI Research Papers 139, Hamburg Institute of International Economics (HWWI).
    31. Otto, Alkis Henri & Steinhardt, Max Friedrich, 2014. "Immigration and election outcomes — Evidence from city districts in Hamburg," Regional Science and Urban Economics, Elsevier, vol. 45(C), pages 67-79.
    32. Augustin de Coulon & Dragos Radu & Max Friedrich Steinhardt, 2016. "Pane e Cioccolata: The Impact of Native Attitudes on Return Migration," Review of International Economics, Wiley Blackwell, vol. 24(2), pages 253-281, May.
    33. Leppin Julian S., 2014. "The Estimation of Reservation Wages: A Simulation-Based Comparison," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 234(5), pages 603-634, October.
    34. Christophe Blot & Fabien Labondance, 2013. "Business lending rate pass-through in the Eurozone: monetary policy transmission before and after the financial crash," Economics Bulletin, AccessEcon, vol. 33(2), pages 973-985.
    35. Christina Boll & Julian Sebastian Leppin & Klaus Schömann, 2016. "Who is overeducated and why? Probit and dynamic mixed multinomial logit analyses of vertical mismatch in East and West Germany," Education Economics, Taylor & Francis Journals, vol. 24(6), pages 639-662, November.
    36. Breitenfellner, Bastian & Wagner, Niklas, 2012. "Explaining aggregate credit default swap spreads," International Review of Financial Analysis, Elsevier, vol. 22(C), pages 18-29.
    37. 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.
    38. Lof, Matthijs, 2012. "Heterogeneity in stock prices: A STAR model with multivariate transition function," Journal of Economic Dynamics and Control, Elsevier, vol. 36(12), pages 1845-1854.
    39. Tang, Dragon Yongjun & Yan, Hong, 2010. "Market conditions, default risk and credit spreads," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 743-753, April.
    40. Massacci, Daniele, 2013. "A switching model with flexible threshold variable: With an application to nonlinear dynamics in stock returns," Economics Letters, Elsevier, vol. 119(2), pages 199-203.
    41. Jan Wedemeier, 2011. "Creative professionals and high-skilled agents': Polarization of employment growth?," ERSA conference papers ersa11p489, European Regional Science Association.
    42. Chan, Kam Fong & Marsden, Alastair, 2014. "Macro risk factors of credit default swap indices in a regime-switching framework," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 285-308.
    43. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2005. "An Empirical Analysis of the Dynamic Relation between Investment-Grade Bonds and Credit Default Swaps," Journal of Finance, American Finance Association, vol. 60(5), pages 2255-2281, October.
    44. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
    45. Haibin Zhu, 2006. "An Empirical Comparison of Credit Spreads between the Bond Market and the Credit Default Swap Market," Journal of Financial Services Research, Springer;Western Finance Association, vol. 29(3), pages 211-235, June.
    46. Wang, Hao & Zhou, Hao & Zhou, Yi, 2013. "Credit default swap spreads and variance risk premia," Journal of Banking & Finance, Elsevier, vol. 37(10), pages 3733-3746.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Thomas Dimpfl & Franziska J. Peter, 2015. "Price discovery in the markets for credit risk: A Markov switching approach," SFB 649 Discussion Papers SFB649DP2015-035, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    2. Chen, Zhenxi & Reitz, Stefan, 2016. "Dynamics of the European sovereign bonds and the identification of crisis periods," FinMaP-Working Papers 57, Collaborative EU Project FinMaP - Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents.
    3. Demetrescu, Matei & Leppin, Julian Sebastian & Reitz, Stefan, 2017. "Homogenous vs. heterogenous transition functions in smooth transition regressions: A LM-type test," Kiel Working Papers 2094, Kiel Institute for the World Economy (IfW).

    More about this item

    Keywords

    CDS spreads; Financial Crisis; Panel Smooth Transition;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:ifwkwp:1946. 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: (ZBW - German National Library of Economics). General contact details of provider: http://edirc.repec.org/data/iwkiede.html .

    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 CitEc recognized a reference but did not link an item in RePEc 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.