Dynamic Dependence and Diversification in Corporate Credit

Peter Christoffersen, Kris Jacobs, Xisong Jin, Hugues Langlois

Research output: Contribution to conferencePaperResearchpeer-review

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.
Original languageEnglish
Publication date4 Jun 2014
Number of pages46
Publication statusPublished - 4 Jun 2014
EventThe 12th International Paris December Finance Meeting - Paris, France
Duration: 18 Dec 201418 Dec 2014
Conference number: 12
https://www.eurofidai.org/en/december_2014.html

Conference

ConferenceThe 12th International Paris December Finance Meeting
Number12
CountryFrance
CityParis
Period18/12/201418/12/2014
Internet address

Cite this

Christoffersen, P., Jacobs, K., Jin, X., & Langlois, H. (2014). Dynamic Dependence and Diversification in Corporate Credit. Paper presented at The 12th International Paris December Finance Meeting, Paris, France.
Christoffersen, Peter ; Jacobs, Kris ; Jin, Xisong ; Langlois, Hugues. / Dynamic Dependence and Diversification in Corporate Credit. Paper presented at The 12th International Paris December Finance Meeting, Paris, France.46 p.
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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.",
keywords = "Credit risk, Default risk, CDS, Dynamic dependence, Copula",
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Christoffersen, P, Jacobs, K, Jin, X & Langlois, H 2014, 'Dynamic Dependence and Diversification in Corporate Credit' Paper presented at, Paris, France, 18/12/2014 - 18/12/2014, .

Dynamic Dependence and Diversification in Corporate Credit. / Christoffersen, Peter ; Jacobs, Kris; Jin, Xisong; Langlois, Hugues.

2014. Paper presented at The 12th International Paris December Finance Meeting, Paris, France.

Research output: Contribution to conferencePaperResearchpeer-review

TY - CONF

T1 - Dynamic Dependence and Diversification in Corporate Credit

AU - Christoffersen, Peter

AU - Jacobs, Kris

AU - Jin, Xisong

AU - Langlois, Hugues

PY - 2014/6/4

Y1 - 2014/6/4

N2 - 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.

AB - 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.

KW - Credit risk

KW - Default risk

KW - CDS

KW - Dynamic dependence

KW - Copula

M3 - Paper

ER -

Christoffersen P, Jacobs K, Jin X, Langlois H. Dynamic Dependence and Diversification in Corporate Credit. 2014. Paper presented at The 12th International Paris December Finance Meeting, Paris, France.