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Rating-based CDS curves

Kolokolova, Olga and Lin, Ming-Tsung and Poon, Ser-Huang (2019) 'Rating-based CDS curves.' The European Journal of Finance, 25 (7). 689 - 723. ISSN 1351-847X

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Abstract

This paper explores the extent to which term structure of individual credit default swap (CDS) spreads can be explained by the firm's rating. Using the Nelson–Siegel model, we construct, for each day, CDS curves from a cross-section of CDS spreads for each rating class. We find that individual CDS deviations from the curve tend to diminish over time and CDS spreads converge towards the fitted curves. The likelihood of convergence increases with the absolute size of the deviation. The convergence is especially stable if CDS spreads are lower relative to the rating-based curve. Trading strategies exploiting the convergence generate an average return of 3.7% (5-day holding period) and 9% (20-day holding period).

Item Type: Article
Uncontrolled Keywords: Credit default swap, trading strategy, CDS term structure, credit rating
Divisions: Faculty of Social Sciences > Essex Business School
Faculty of Social Sciences > Essex Business School > Essex Finance Centre
Depositing User: Elements
Date Deposited: 06 Nov 2019 09:47
Last Modified: 29 Feb 2020 02:00
URI: http://repository.essex.ac.uk/id/eprint/25812

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