Exponential Lévy Models Extended by a Jump to Default

This article establishes an original methodology to forecast macroeconomy based on the term structure of credit spreads. It combines the traditional Svensson model with genetic algorithms to obtain the interest rate term structures of government bonds and corporate bonds and calculates credit spreads as their differences. And this article defines three factors of the term structure of credit spreads: level, slope and curvature. Based on these three factors and several macroeconomic variables, VAR models are developed and tested to forecast macroeconomic variables. The empirical results confirm that VAR models can predict the changes of China's macroeconomy well, which indicates that the term structure of credit spreads contains information of future changes of macroeconomic variables. We believe this result has significant implications for macroeconomy policy-makers.

The Term Structure of Credit Spreads in Project Finance

This paper develops a two-dimensional structural framework for valuing credit default swaps and corporate bonds in the presence of default contagion. Modelling the values of related firms as correlated geometric Brownian motions with exponential default barriers, analytical formulae are obtained for both credit default swap spreads and corporate bond yields. The credit dependence structure is influenced by both a longer-term correlation structure as well as by the possibility of default contagion. In this way, the model is able to generate a diverse range of shapes for the term structure of credit spreads using realistic values for input parameters.

Comparing asset swap spreads across bonds is a widely used tool for measuring relative value. This approach leads portfolio managers to increase their risk exposure in ways that are not transparent. Credit default swaps are utilized to demonstrate that viewing wide asset swaps as an indicator of relative value is a mirage. The paper documents the empirical regularities in the term structure of credit spreads and spread volatilities that make this result possible. In addition, we present empirical evidence of the imprint made on corporate bond returns by the widespread use of the asset swaps data.

Credit risk, valuation and fundamental analysis

Credit risk pricing is perhaps an understudied topic in comparisons to its profound impact on the world’s financial markets and economies. This study uses established price discovery techniques to develop a method of price discovery for credit risk in three financial markets: equity, debt, and credit derivative. This chapter is motivated by the development of credit-related instruments and signals of stock price movements of South-Eastern European countries—Bulgaria, Croatia, Greece, Hungary, Romania, Slovenia, Slovakia, and Turkey—during the recent financial crisis. In this study, the authors evaluate the dynamics of fiscal risk or country risk measured by sovereign Credit Default Swap (CDS), liquidity risk measured bond markets, and stock markets for the monthly based September 2008 – February 2011 period. The study examines monthly data observing 38 months and 8 countries. A panel vector autoregression model is proposed for changes in Long-Term Interest Rate (LTIR), changes in CDS spreads (CDS), and changes in stock index. In conclusion, CDS markets and stock markets are more significant than bond markets in explaining the post-crisis relationship among developing South-Eastern European countries. The analysis displays that long-term monetary policy did not affect CDS premium and stock index level. A strong relationship is found between the CDS spread and stock market. During financial crisis and after the crisis, the correlations among CDS, stock, and bond markets are collapsed by panicked investors’ rapid movement and wild speculators. This risk perception can explain the difference between the finance theory and practices in the market.

Hazardous Hedging: The (Unacknowledged) Risks of Hedging with Credit Default Swaps

Do Credit Spreads Reflect Stationary Leverage Ratios? Reconciling Structural and Reduced-Form Frameworks

Understanding Decreasing CDS Curves

Up until the year 2008 the credit derivatives market had been skyrocketing. Unfortunately in the year 2008 it turned out that credit derivatives were the cause of a worldwide financial crisis. One of the most popular and useful credit derivatives is the credit default swap which is presented in this paper. The author describes CDS transactions and shows forms of this product. Moreover the advantages and disadvantages of this derivative are depicted.

This chapter highlights aspects of the vibrant ongoing research program associated with the ideas developed in earlier chapters. It begins with a collage-style sketch of work involving Bayesian analysis, functional form for factor loadings, term structures of credit spreads, and nonlinearities. It then discusses in greater detail the incorporation of more than three yield factors. Next, it treats stochastic volatility in both dynamic Nelson–Siegel model (DNS) and arbitrage-free DNS (AFNS) environments, with some attention to the issue of unspanned stochastic volatility. Finally, it discusses the incorporation of macroeconomic fundamentals in their relation to bond yields. It also introduces aspects of modeling real versus nominal yields in DNS/AFNS environments, a theme treated in detail in Chapter 5.

ABSTRACTWe investigate a structural model of market and firm‐level dynamics in order to jointly price long‐dated S&P 500 index options and CDO tranches of corporate debt. We identify market dynamics from index option prices and idiosyncratic dynamics from the term structure of credit spreads. We find that all tranches can be well priced out‐of‐sample before the crisis. During the crisis, however, our model can capture senior tranche prices only if we allow for the possibility of a catastrophic jump. Thus, senior tranches are nonredundant assets that provide a unique window into the pricing of catastrophic risk.

We study bond prices in Black–Cox model with jumps in asset value. We assume that the jump size distribution is arbitrary and, if default occurs, following Longstaff and Schwartz [A Simple Approach to Valuing Risky Fixed and Floating Rate Debt. Journal of Finance 50 (1995), 789–819] and Zhou [The Term Structure of Credit Spreads with Jump Risk. Journal of Banking & Finance 26 (2001), 2015–2040], the payoff at maturity date depends on a general write-down function. Under this general setting, we propose an integral equation approach for the bond prices. As an application of this approach, we study the analytic properties of the bond prices. Also we derive an infinite series expression for the bond prices.

Accounting Transparency and the Term Structure of Credit Spreads

Investment-Based Corporate Bond Pricing