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Working Paper
Bayesian Estimation of Time-Changed Default Intensity Models
We estimate a reduced-form model of credit risk that incorporates stochastic volatility in default intensity via stochastic time-change. Our Bayesian MCMC estimation method overcomes nonlinearity in the measurement equation and state-dependent volatility in the state equation. We implement on firm-level time-series of CDS spreads, and find strong in-sample evidence of stochastic volatility in this market. Relative to the widely-used CIR model for the default intensity, we find that stochastic time-change offers modest benefit in fitting the cross-section of CDS spreads at each point in time, ...
Journal Article
The Long and Short of It: The Post-Crisis Corporate CDS Market
The authors establish key stylized facts about the post-crisis evolution of trading and pricing of credit default swaps. Using supervisory contract-level data, they show that dealers became net buyers of credit protection starting in the second half of 2014, both through reducing the amount of protection they sell in the single-name market and switching to buying protection in the index market. More generally, they argue that considering simultaneous positions in different types of credit derivatives is crucial for understanding institutions’ decisions to participate in these markets and ...
Working Paper
Credit Default Swaps in General Equilibrium: Spillovers, Credit Spreads, and Endogenous Default
This paper highlights two new effects of credit default swap markets (CDS) in a general equilibrium setting. First, when firms' cash flows are correlated, CDSs impact the cost of capital{credit spreads{and investment for all firms, even those that are not CDS reference entities. Second, when firms internalize the credit spread changes, the incentive to issue safe rather than risky bonds is fundamentally altered. Issuing safe debt requires a transfer of profits from good states to bad states to ensure full repayment. Alternatively, issuing risky bonds maximizes profits in good states at the ...