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Jun 22

Credit Default Spread and Historical Volatility

Posted by abiao at 12:24 | Others | Comments(0) | Reads(7662)
Credit Default Spread (CDS) reflects the default risk of a company, Zhong, Cao et al. (2010) argue CDS is similar to out-of-the-money put options in that both offer a low cost and effective protection against downside risk. They then investigates that put option-implied volatility is an important determinant of CDS spreads.

Since I can't get access to OptionMetrics database, I plot a graph showing the relation between average daily 5-year CDS downloaded from CMA, Datastream and simple average historical volatility measured by exponentially weighted moving average (EWMA) of 355 US entities, how amazingly close is the co-movement of these two series.
cds spread volatility

Zhong, Z. D., C. Cao, et al. (2010). "The information content of option-implied volatility for credit default swap valuation." Journal of Financial Markets 13(3): 321-343.

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