The spread risk premium component of credit default swap (CDS) spreads represents a compensation demanded by protection sellers for future changes in CDS spreads caused by unpredictable fluctuations in the reference entity's risk-neutral default intensity. This paper defines and estimates a measure of the spread risk premium component in CDS spreads of a sample of European investment-grade firms by using a stochastic intensity credit model. Our results show that, on average, investors demand a positive premium for such mark-to-market risks. After controlling for CDS market conditions, like liquidity and supply/demand effects, a panel data analysis of the estimated spread risk premia reveals among other things a significant positive impact of event risk captured by the overall stock market volatility and of investors' appetite for exposure to credit markets as reflected by the overall CDS market.

This article studies the economic factors behind corporate default risk premia in Europe during the period 2006-2010. We employ information embedded in Credit Default Swap (CDS) contracts to quantify expected excess returns from the underlying bonds in market-wide default circumstances. We disentangle the compensation to investors for unexpected changes in the creditworthiness of the bond issuer from their remuneration for the risk that the bond's price will drop in the event of default. Our results show that the risk premia associated with systematic factors influencing default arrivals represent approximately 40% of total CDS spread (on median). These premia also exhibit a strong source of commonality; a single principal component explains approximately 88% of their joint variability. This factor significantly covaries with aggregate illiquidity and sovereign risk variables. Empirical evidence suggests a public-to-private risk transfer between sovereign credit spread and corporate risk premia. Finally, the compensation in the event of default is approximately 14 basis points of the total CDS spread, and a significant amount of jump-at-default risk may not be diversifiable.

This paper estimates recent default risk premia for U.S. corporate debt, based on a close relationship between default probabilities, as estimated by Moody's KMV EDFs, and default swap (CDS) market rates. The default-swap data, obtained through CIBC from 22 banks and specialty dealers, allow us to establish a strong link between actual and risk-neutral default probabilities for the 69 firms in the three sectors that we analyze: broadcasting and entertainment, healthcare, and oil and gas. We find dramatic variation over time in risk premia, from peaks in the third quarter of 2002, dropping by roughly 50% to late 2003.

Seminar paper from the year 2010 in the subject Business economics - Investment and Finance, grade: 67%, University of Westminster (Westminster Business School), course: Financial Derivatives, language: English, abstract: "A credit default swap (CDS) is a bilateral agreement designed explicitly to shift credit risk between two parties. In a CDS, one party (protection buyer) pays a periodic fee to another party (protection seller) in return for compensation for default (or similar credit event) by a reference entity". Credit Default Swaps (CDS) are by far the most popular credit derivatives and have proven to be the most successful financial innovation. The structure of CDS is somewhat similar to the insurance policy. The market of CDS has heavily expanded and is traded in Over-The-Counter (OTC) market. This essay will briefly address the structure and the market of CDS, outlining its common products usage by some large institutions. Following the review of financial structure and pricing of CDS. And finally, this essay will also evaluate the risk management and investment applications of such products.

Inhaltsangabe:Introduction: Credit default swaps are by far the most often traded credit derivatives and the credit default swap markets have seen tremendous growth over the past two decades. Put simply, a credit default swap is a tradeable contract that provides insurance against the default of a certain debtor. Initially, when the first form of a credit default swap (CDS) was traded in 1991, they were mainly used by commercial banks in order to lay off credit risk to insurance companies. However, focus shifted in the subsequent years as new players entered the market. Hedge funds became big players, money managers and reinsurers entered, and banks started to not only buy protection on their assets but also sell protection in order to diversify their portfolios. All this led to today s CDS market being dominated by investors rather than banks and, as a consequence, CDSs are now structured to meet investors needs instead of those of the banks. Over the same time as this shift to an investor orientated market took place, CDS markets grew at an astonishing rate with notional amount outstanding pretty much doubling every year until peaking in the second half of 2007 at USD 62,173.20 billions. The need to effciently transfer credit risk as well as the increasing standardization of CDS contracts by the International Swaps and Derivatives Association propelled this development. Only in 2008 did the notional amount outstanding in CDSs retract for the first time and come down to USD 31,223.10 billion in the first half of 2009. A partial reason was the full blown financial crisis in which CDSs also played a prominent role. The demise of Lehman Brothers, for example, triggered roughly USD 400 billion in protection payments and American International Group needed to be bailed out in 2008 because it had sold too much CDS protection. Amongst other concerns, these incidents highlight the systemic importance of CDSs. Combined with the phenomenal growth of CDS markets, this makes CDSs a highly relevant component of the current ?nancial environment and a fruitful subject for academic research. Today, just like most other financial instruments, CDSs serve a multitude of purposes spanning hedging, speculation, and arbitrage. The aim of this thesis is to explore these uses further and answer the following research questions: What CDS trading strategies are commonly used and how does a selection of these strategies CDS curve trades including forward CDSs, [...]

Credit Default Swaps: A Survey is the most comprehensive review of all major research domains involving credit default swaps (CDS). CDS have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly since the credit crisis of 2007-2009. The authors review the extant literature on CDS that has accumulated over the past two decades and divide the survey into seven topics after providing a broad overview in the introduction. The second section traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third section discusses the pricing of CDS, from the perspective of no-arbitrage principles, structural, and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth section discusses how the development of the CDS market has affected the characteristics of the bond and equity markets, with an emphasis on market efficiency, price discovery, information flow, and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market. The fifth section examines the effect of CDS trading on firms' credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and corporate governance. The sixth section analyzes how CDS impact the economic incentives of financial intermediaries. The seventh section reviews the growing literature on sovereign CDS and highlights the major differences between the sovereign and corporate CDS markets. The eighth section discusses CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis. The authors close with our suggestions for promising future research directions on CDS contracts and markets.