Regime dependent determinants of credit default swap spread
HongBae Kim
Yeonjeong Lee
Seong-Min Yoon
This study investigates the influence of theoretical determinants on the Korea sovereign credit default swap (CDS) spreads from January 2007 to September 2009 based on structural credit risk model. Stock returns and Interest rates have a significant effect on the CDS spreads among the theoretical determinants of structural credit risk models. Implied volatility has more significant influence on the CDS spreads than historical volatility. CDS spreads may behave quite differently during volatile regime compared with their behavior in tranquil regime. We therefore apply Markov switching model to investigate the possibility that the influence of theoretical determinants of CDS spread has a regime dependent behavior. In all regimes Korean sovereign CDS spreads are highly sensitive to stock market returns, whereas in tranquil regime interest rates also have influence on CDS spreads. We conclude that for the efficient hedging of CDS exposure trader should adjust equity hedge ratio to the relevant regime.
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