XXV Edition

1-2 December 2016"

The Determinants of CDS Spreads: Evidence from the Model Space

Pelster Matthias, Leuphana University
Vilsmeier Johannes, Deutsche Bundesbank

We apply Bayesian Model Averaging and a frequentistic model space analysis to assess the pricing determinants of credit default swaps (CDS). Our study focuses on the complete model space of plausible models and thus supports ultimate transparency and robustness. Using a large dataset of CDS contracts we find that CDS price dynamics can be mainly explained by factors describing firms' sensitivity to extreme market movements. More precisely, our results suggest that dynamic copula based measures of tail dependence incorporate most essential pricing information, making other potential determinants such as Merton-type factors or linear variables measuring the systematic market evolution negligible.

Area: Asset Pricing and Derivatives

Keywords: CDS; Bayesian model averaging; crash aversion; tail risk; tail dependence; time-varying copulas.

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