Default correlation is a concern especially after witnessing the financial crisis. To find default correlations, we would like to know asset correlations which are unobservable. In this paper we derive a model to infer asset correlations from Credit Default Swaps (CDSs). We use a structural model approach with the first passage time as default. The resulting model is closed-form and extremely easy to compute. Using the data from 2004 to 2008, we find the average implied asset correlation from CDS to be over 0.4. The average equity correlation, which is usually used as a proxy for asset correlation, over the same period is 0.155. The result complies with the literature that there is another unobservable factor driving defaults among firms.
{"title":"Inferring Asset Correlations from CDS Spreads: A Structural Model Approach","authors":"Chanatip Kitwiwattanachai, Neil D. Pearson","doi":"10.2139/ssrn.2138448","DOIUrl":"https://doi.org/10.2139/ssrn.2138448","url":null,"abstract":"Default correlation is a concern especially after witnessing the financial crisis. To find default correlations, we would like to know asset correlations which are unobservable. In this paper we derive a model to infer asset correlations from Credit Default Swaps (CDSs). We use a structural model approach with the first passage time as default. The resulting model is closed-form and extremely easy to compute. Using the data from 2004 to 2008, we find the average implied asset correlation from CDS to be over 0.4. The average equity correlation, which is usually used as a proxy for asset correlation, over the same period is 0.155. The result complies with the literature that there is another unobservable factor driving defaults among firms.","PeriodicalId":185010,"journal":{"name":"Bankrupt Firms and Their Relation to Other Firms","volume":"116 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-08-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124221858","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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