Determinants of Credit Default Swap Spreads in the iTraxx Europe Index Family

Abstract

This paper investigates the economic and financial drivers of CDS spreads and their changes. Specifically, the analysis is limited on CDSs with European reference entities over a timeframe between January 2012 and December 2017. Several interesting results are obtained. The paper finds evidence that pockets of the CDS markets are inefficiently priced and that the CDS market is segmented to a certain degree from equity, rates and foreign exchange markets. This finding is complemented by evidence for a credit market specific factor relevant for explaining CDS spreads and their changes independent of the liquidity of the underlying CDS contract. Finally, we find that changes as well as the level of CDS spreads is largely determined by systemic factors as opposed to company specific, fundamental variables. This paper hence contributes to the discussion about adequate pricing and hedging models for credit risk.