Fundamentals, real-time uncertainty and CDS index spreads

Audzeyeva, Alena; Wang, Xu

Abstract

The high level of economic uncertainty linked to the pace of the recovery process can persist after a crisis and has implications for the market pricing of firms’ credit risk reflected in credit default swap (CDS) spreads. This paper examines the role of key proxies for the economic state and its real-time uncertainty in determining Northern American CDX index spreads. Focusing on the recovery period following the 2007–2009 global financial crisis, we find that measures of economic output, employment, inflation, and economic uncertainty, all significantly influence CDX spreads, beyond the impact of conventional determinants. Furthermore, our results provide evidence that the sensitivity of investment-grade and high-yield CDX differs across economic aspects. Moreover, our out-of-sample predictive analysis identifies indicators and uncertainty measures with significant predictive content for quarter-ahead CDX spreads. Taken together, our findings indicate that academic modelers and practitioners employing more accurate representations of the macroeconomy in CDS modeling and analysis can improve upon the models that rely solely on the typically employed economic output variables or on broad data aggregation.

Citation

Audzeyeva, A., & Wang, X. (2023). Fundamentals, real-time uncertainty and CDS index spreads. Review of Quantitative Finance and Accounting, 61(1), 1-33. https://doi.org/10.1007/s11156-023-01127-6

• Journal Article Type: Article
• Acceptance Date: Jan 9, 2023
• Online Publication Date: Apr 12, 2023
• Publication Date: Jul 1, 2023
• Publicly Available Date: Jun 20, 2023
• Journal: Review of Quantitative Finance and Accounting
• Print ISSN: 0924-865X
• Electronic ISSN: 1573-7179
• Publisher: Springer Verlag
• Peer Reviewed: Peer Reviewed
• Volume: 61
• Issue: 1
• Pages: 1-33
• DOI: https://doi.org/10.1007/s11156-023-01127-6
• Keywords: CDS index, Macroeconomic fundamentals, Credit spread forecasting, Macroeconomic uncertainty, G17, G12, Credit spreads, E44, Economist survey nowcasts
• Publisher URL: https://link.springer.com/article/10.1007/s11156-023-01127-6