Investigating the Dependence Structure between Credit Default Swap Spreads and the U.S. Financial Market

Abstract : Under Basel II framework, credit risk assessment is of high significance in the light of correlation risk. Correlation risk is often envisioned along with business conditions and financial market's impact.We employ copula methodology to identify the dependence structures that may exist between market risk fundamentals and credit risk fundamentals. Considering credit derivative spreads as credit risk fundamentals and market data asmarket risk determinants, we describe and quantify the asymmetric link prevailing between credit risk and market risk. Credit risk is negatively linked with market price risk whereas it becomes positively linked with market volatility risk. Such patterns give rise to interesting asymmetric dependence structures between both risk sources. We are then able to balance reliably market price risk with market volatility feedback, the market trend supporting a common correlation between securities. In the light of the previous trade-off, we propose also a simple credit risk management rule.
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Hayette Gatfaoui. Investigating the Dependence Structure between Credit Default Swap Spreads and the U.S. Financial Market. Annals of Finance, Springer Verlag, 2010, Vol. 6, pp. 511-535. ⟨10.1007/s10436-009-0139-5⟩. ⟨hal-00565525⟩

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