Exploring for the Determinants of Credit Risk in Credit Default Swap Transaction Data

TLDR: In this paper, the influence of various fundamental variables on a cross-section of credit default swap rates was investigated, including ratings, interest rate data and stock market related information such as variance and leverage.

Abstract: We investigate the influence of various fundamental variables on a cross-section of credit default swap rates. Credit default swap rates can be seen as an alternative proxy for credit risk. Therefore our findings are relevant not only for the understanding of credit default swaps but for credit risk in general. The fundamental variables include ratings, interest rate data and stock market related information such as variance and leverage (so called "structural variables"). We test for the stability of the influence of the different fundamental variables along several lines. We find evidence that most of the variables predicted by credit risk pricing theories have a significant impact on the observed levels of credit default prices. We also provide an international analysis of corporate credit risk, as half of our corporate sample is not US based, as well as some results on sovereign credit risk. Using this information we are able to explain a significant portion of the cross-sectional variation in our sample with adjusted R2 reaching 82% using the variables predicted by classical theoretical models. However there are important behavioral differences between high rated and low rated underlyings, sovereign and corporate underlyings and underlyings from different markets (US vs no US). We analyze these differences. Strong results show the importance of considering so called "structural variables" as well as stochastic interest rates along with classical ratings when pricing credit risk overall.