Final published version
Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - Rating-Based CDS Curves
AU - Kolokolova, Olga
AU - Poon, Ser-Huang
AU - Lin, Ming-Tsung
PY - 2019/1/31
Y1 - 2019/1/31
N2 - 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).
AB - 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).
U2 - 10.1080/1351847X.2018.1511441
DO - 10.1080/1351847X.2018.1511441
M3 - Journal article
VL - 25
SP - 689
EP - 723
JO - European Journal of Finance
JF - European Journal of Finance
SN - 1351-847X
IS - 7
ER -