Abstract
We characterize dependence and tail dependence in corporate credit using a new
class of dynamic copula models which can capture dynamic dependence and asymmetry in large samples of firms. We also document important differences between the dependence dynamics for credit spreads and equity returns. Modeling a decade of weekly CDS spreads for 215 firms, we find that copula correlations are highly time-varying and persistent, and that they increase significantly in the financial crisis and have remained high since. Perhaps most importantly, tail dependence of CDS spreads increases even more than copula correlations during the crisis and remains high as well. The most important shocks to credit dependence occur in August of 2007 and in August of 2011,
but interestingly these dates are not associated with significant changes to median credit spreads. The decrease in diversification potential caused by the increase in dependence and tail dependence is large. Finally, we find that the CDS volatility, correlation and tail dependence measures that we have constructed using the dynamic copula model are important determinants of credit spreads over time.
class of dynamic copula models which can capture dynamic dependence and asymmetry in large samples of firms. We also document important differences between the dependence dynamics for credit spreads and equity returns. Modeling a decade of weekly CDS spreads for 215 firms, we find that copula correlations are highly time-varying and persistent, and that they increase significantly in the financial crisis and have remained high since. Perhaps most importantly, tail dependence of CDS spreads increases even more than copula correlations during the crisis and remains high as well. The most important shocks to credit dependence occur in August of 2007 and in August of 2011,
but interestingly these dates are not associated with significant changes to median credit spreads. The decrease in diversification potential caused by the increase in dependence and tail dependence is large. Finally, we find that the CDS volatility, correlation and tail dependence measures that we have constructed using the dynamic copula model are important determinants of credit spreads over time.
| Original language | English |
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| Publication date | 4 Jun 2014 |
| Number of pages | 46 |
| Publication status | Published - 4 Jun 2014 |
| Event | The 12th International Paris December Finance Meeting - Paris, France Duration: 18 Dec 2014 → 18 Dec 2014 Conference number: 12 https://www.eurofidai.org/en/december_2014.html |
Conference
| Conference | The 12th International Paris December Finance Meeting |
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| Number | 12 |
| Country/Territory | France |
| City | Paris |
| Period | 18/12/2014 → 18/12/2014 |
| Internet address |