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Nov 13

CDS Inferred Stock Volatility

Posted by abiao at 08:29 | Paper Review | Comments(33) | Reads(10102)
I have written a working paper on CDS (credit default swap) implied stock volatility and found some interesting results. Post it here just in case someone is interested.

Both CDS and out-of-money put option can protect investors against downside risk, so they are related while not being mutually replaceable. This study provides a straightforward linkage between corporate CDS and equity option by inferring stock volatility from CDS spread and, thus, enables a direct analogy with the implied volatility from option price. I find CDS inferred volatility (CIV) and option implied volatility (OIV) are complementary, both containing some information that is not captured by the other. CIV dominates OIV in forecasting stock future realized volatility. Moreover, a trading strategy based on the CIV-OIV mean reverting spreads generates significant risk-adjusted return. These findings complement existing empirical evidence on cross-market analysis.

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