Annals of Operations Research

, Volume 205, Issue 1, pp 89–107

CDS volatility: the key signal of credit quality

Article

DOI: 10.1007/s10479-012-1244-9

Cite this article as:
Castellano, R. & D’Ecclesia, R.L. Ann Oper Res (2013) 205: 89. doi:10.1007/s10479-012-1244-9

Abstract

This paper investigates the role of CDS volatility in providing information concerning the credit quality of a company.

In Castellano and D’Ecclesia (J. Financ. Decis. Mak. 2:27, 2011) a first analysis of how CDS quotes respond to rating announcements is provided and it showed that market participants do not rely much on Rating Agencies, especially during periods characterized by very high volatility, i.e. during a financial crisis. Here, a more accurate analysis of the CDS’s ability to provide timely information on the creditworthiness of reference entities is performed, estimating the volatility of CDS quotes by using Exponential GARCH(1,1) models. The event study methodology is applied to a sample of CDS quotes for US and European markets, over the period 2004–2009. Results provide an accurate understanding of market behavior in the presence of news released by Rating Agencies. Overall, market participants seem to provide timely reactions around the event date and we show that the key element of signaling is represented by the changing volatility in CDS quotes, before and after the rating event.

Keywords

Credit default swaps Event study Exponential GARCH 

Copyright information

© Springer Science+Business Media New York 2012

Authors and Affiliations

  1. 1.University of MacerataMacerataItaly
  2. 2.University of Rome “La Sapienza”RomeItaly

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