Li, Nan (2004): The Implied Benchmark Rate in the Credit Default Swap Market of Sovereign Bonds.
Download (225Kb) | Preview
Credit default swap(CDS) is a new developed derivative to insure the credit risk of an underlying entity. This paper investigates the correlation relationship of the CDS market of sovereign borrowers and sovereign bond market. Applying the formula in the paper of Hull et al.(2004), an implied default-free rate(also called benchmark rate) of CDS market is computed; its correlations with US treasury and LIBOR are tested respectively. The tests indicate that,in sovereign CDS market, the benchmark is more related with US treasury, although LIBOR has been used as the best approximation of market benchmark in both academia and industry. Therefore, this paper suggest the importance of US treasury to sovereign CDS market in measuring market's reference and searching for mispriced chance.In addition, a spuriously controversy result are found as rating-specific CDS benchmark rates are contrasted. A monotonic decrease of these benchmarks is clearly observed for the sovereigns with lower credit rating and higher default risk. The phenomenon is carefully explained and the main reason comes from the higher CDS rate than yield spread. This invites a further comparison of the price discovery processes in sovereign CDS market and the corresponding sovereign bond market.
|Item Type:||MPRA Paper|
|Original Title:||The Implied Benchmark Rate in the Credit Default Swap Market of Sovereign Bonds|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates|
|Depositing User:||Nan Li|
|Date Deposited:||14. Aug 2008 07:55|
|Last Modified:||12. Feb 2013 02:20|
 Avramov, Doron, Gergana Jostova, and Alexander Philipov, 2004, Corporate Credit Risk Changes: Common Factors and Firm-Level Fundamentals, Working paper, Unversity of Maryland; George Washington University; Fannie Mae.
 Chan-Lau, Jorge A., and Yoon Sook Kim, 2004, Equity Prices, Credit Default Swaps and Bond Spreads in Emerging Markets, IMF Working Paper.
 Duffie, Darrell, and Kenneth J. Singleton, Credit Risk, 2004.
 Duffie, Darrell, Lasse H. Pedersen, and Kenneth J. Singleton, 2003, Modeling Sovereign Yield Spreads: A Case Study of Russian Debt, Journal of Finance.
 Houweling, Patrick, and Ton Vorst, 2003, Pricing Default Swaps: Empirical Evidence, Journal of International Money and Finance, Forthcoming.
 Hull, John, and Alan White, 2000, Valuing Credit Default Swaps: No Counterparty Default Risk, Journal of Derivatives, Vol.8, pp.29 40.
 Hull, John, Mirela Predescu, and Alan White, 2004, The Relationship BetIen Credit Default Swap Spreads, Bond Yields, And Credit Rating Announcements, Journal of Banking and Finance, forthcoming.
 Lehnert, Thorsten, and Frederick Neske, 2004, On the Relationship Between Credit Rating Announcements and Credit Default Swap Spreads for European Reference Entities, Working paper, Maastricht Unversity.
 Longstaff, Francis A., Sanjay Mithal, and Eric Neis, 2003, The Credit Default Swap Markte: Is Credit Protection Priced Correctly?, Working paper, UCLA.
 Longstaff, Francis A., Sanjay Mithal, and Eric Neis, 2004, Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market, Working paper, UCLA.
 Neftci, Salih, Andre Oliveira Santos, and Yinqiu Lu, 2004, Credit Default Swaps and Financial Crisis Prediction. Working paper, City University of New York.
 Frank X. Zhang, 2003, What Did the Credit Market Expect of Argentina Default? Evidence from Default Swap Data, Working paper, Federal Reserve Board.