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Default Clustering Risk Premium and its Cross-Market Asset Pricing Implications.

Authors :
Kiwoong Byun
Baeho Kim
Dong Hwan Oh
Source :
Working Papers: U.S. Federal Reserve Board's Finance & Economic Discussion Series; Aug2023, p1-31, 31p
Publication Year :
2023

Abstract

This study examines the market-implied premiums for bearing default clustering risk by analyzing credit derivatives contracts on the CDX North American Investment Grade (CDX.NA.IG) portfolio between September 2005 and March 2021. Our approach involves constructing a time series of reference tranche rates exclusively derived by single-name CDS spreads. The default clustering risk premium (DCRP) is captured by comparing the original and reference tranche spreads, with the former exceeding the latter when investors require greater compensation for correlated defaults at the portfolio level. The fitted DCRP level significantly increased in response to the 2007-9 global financial crisis and remained relatively stable for a period, followed by a gradual decline beginning in 2016. Notably, the COVID-19 shock caused another sharp rise in the DCRP level. Our empirical analysis finds that the estimated DCRP has significant implications for asset pricing, particularly in affecting the investment opportunities available to U.S. stock investors during times of instability in the financial system. [ABSTRACT FROM AUTHOR]

Details

Language :
English
ISSN :
19362854
Database :
Complementary Index
Journal :
Working Papers: U.S. Federal Reserve Board's Finance & Economic Discussion Series
Publication Type :
Report
Accession number :
171576742
Full Text :
https://doi.org/10.17016/FEDS.2023.055