Keywords: Structural model, stochastic volatility, jumps, credit spread, nonlinear effect, high-frequency data
Abstract: A structural model with stochastic volatility and jumps implies
specific relationships between observed equity returns and
credit spreads. This paper explores such effects in the credit
default swap (CDS) market. We use a novel approach to identify the
realized jumps of individual equities from high frequency data. Our
empirical results suggest that volatility risk alone predicts 50 percent
of the variation in CDS spreads, while jump risk alone forecasts 19 percent.
After controlling for credit ratings, macroeconomic conditions,
and firms' balance sheet information, we can explain 77 percent of the
total variation. Moreover, the pricing effects of volatility and
jump measures vary consistently across investment-grade and
high-yield entities. The estimated nonlinear effects of volatility
and jumps are in line with the model-implied relationships between
equity returns and credit spreads.
Full paper (333 KB PDF)
Home | FEDS | List of 2005 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: December 19, 2005