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What Drives the Commonality between Credit Default Swap Spread Changes?

Published online by Cambridge University Press:  20 February 2017

Mike Anderson
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Abstract

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This paper documents an increase in the comovement between credit default swap (CDS) spread changes during the 2007–2009 crisis and investigates the source of that increase. One possible explanation is that comovement increased because fundamental values became more correlated. However, I find that changes in fundamentals account for only 23% of the increase in covariance. The remaining increase is attributed to changes in liquidity and the market price of default risk. In contrast, counterparty risk played an insignificant role. Although both contributed, the increase in covariance was driven more by variation in exposures than factor variance–covariance.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 1 , February 2017, pp. 243 - 275
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Footnotes

1 I am grateful for helpful discussion and suggestions from Joost Driessen and Spencer Martin (the referees) and from Jack Bao, Hendrik Bessembinder (the editor), Phil Davies, Darrell Duffie, Kewei Hou, Andrew Karolyi, Rose Liao, Bernadette Minton, Taylor Nadauld, Alex Philipov, Tim Scholl, Ken Singleton, René Stulz, Jennifer Sustersic, Jérôme Taillard, and Scott Yonker. I thank seminar participants at Ohio State University, the U.S. Securities and Exchange Commission, Dimensional Fund Advisors, the University of New South Wales, the Federal Reserve Board, George Mason University, and George Washington University. I also thank the Dice Center for research support.

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