The credit derivatives market has known an incredible development since its advent in the 1990's. Today there is a plethora of credit derivatives going from the simplest ones, credit default swaps (CDS), to more complex ones such as synthetic single-tranche collateralized debt obligations. Valuing this rich panel of products involves modeling credit risk. For this purpose, two main approaches have been explored and proposed since 1976. The first approach is the Structural approach, first proposed by Merton in 1976, following the work of Black-Scholes for pricing stock options. This approach relies in the capital structure of a firm to model its probability of default. The other approach is called the Reduced-form approach or the hazard rate approach. It is pioneered by Duffie, Lando, Jarrow among others. The main thesis in this approach is that default should be modeled as a jump process. The objective of this work is to value Asset-backed Credit default swaps using the hazard rate approach.

This thesis is about the credit default swap market and its development from the moment of its origin to the present. The focus is on the peripheral countries of eurozone, especially on Greece. The first part of the thesis is about the characteristics of CDS contracts, settlement of contracts and the relationship between CDS and insurance contracts. The other parts of the thesis are about the crisis in Greece, the CDS on sovereign greek bonds and the credit event. The last part of the thesis is about CDS on other sovereign bonds of peripheral countries in eurozone which are Spain, Italy and Portugal.

Over the past decade, numerous engineered credit events and cases of market participants manipulating bond prices to influence Credit Default Swap (CDS) auction payouts have occurred. These cases have become increasingly common, and the CFTC has stated they may constitute market manipulation and undermine not only the CDS market but also the credit derivative and default markets. Although there is a plethora of news and media coverage on publicized cases, there is no previous empirical research on evidence of these practices. This paper is motivated by the desire to determine if there is indirect evidence of bond price manipulation around default and of market participants’ attempts to favorably move CDS’s underlying bond prices to achieve more profitable positions around default and emerging from CDS auctions. The analysis is performed by analyzing the effect of a bonds’ inclusion in CDS auctions on bond return volatility around the time of default while controlling for credit risk, illiquidity, firm fundamentals, and other bond-level controls. I find that bond return volatility around default is much higher as a result of a bond’s inclusion in a CDS auction, which serves as indirect evidence of bond price manipulation around default as market participants strive for more profitable CDS auction outcomes and possibly of manufactured credit events. Consistent with previous literature, I also find that bond illiquidity significantly impacts bond return volatility. My results are robust to propensity score matching, implementing double-robust estimators, and controlling for any time-varying cross-sectionally-invariant fluctuations in bond return volatility.

Credit derivatives are among the most criticized financial instruments in the current credit crises. Given their short history, finance professionals are still researching to discover effective ways to reduce the mark-to-market (MTM) volatility in credit derivatives, especially in turbulent market conditions. Many credit portfolios have been struggling to find out appropriate tools and techniques to help them navigate the current credit crises and hedge mark-to-market volatility in their portfolios. In this study we provide a tool kit to help reduce the pricing fluctuations in structured credit portfolios utilizing data analysis and statistical methods. In Chapter One we provide a snapshot of credit derivatives market by summarizing different types of credit derivatives; including single-name credit default swaps (CDS), market credit indices, bespoke portfolios, market index tranches, and bespoke tranches (synthetic CDOs). In Chapter Two we illustrate a method to calculate a stable hedge ratio (beta) by combining industry practices and statistical techniques. Choosing an appropriate hedge ratio is critical for funds that desire to hedge mark-to-market volatility. Many credit portfolios suffered 40%-80% market value losses in 2008 and 2009 due to the mark-to-market volatility in their long positions. In this chapter we introduce ten different betas in order to hedge a long bespoke portfolio by liquid market indices. We measure the effectives of these betas by two measures: Stability and mark-to-market volatility reduction. Among all betas we present, we deduct that the following betas are appropriate to be used as hedge ratios: Implied Beta, Quarterly Regression Beta on Spread Levels, Yearly Regression Betas on Spread Levels, Up Beta, and Down Beta. In Chapter Three we analyze the risk factors that impact the MTM volatility in CDS tranches; namely Spread Risk, Correlation Risk, Dispersion Risk, and Curve Risk. We focus our analysis in explaining the risks in the equity tranche as this is the riskiest tranche in the capital structure. We show that all four risks introduced are critical in explaining MTM volatility in equity tranches. We also perform multiple regression analysis to show the correlations between different risk factors. We show that, when combined, spread, correlation, and dispersion risks are the most important risk factors in analyzing MTM fluctuations in equity tranche. Curve risk can be used as an add-on risk to further explain local instances. After understanding various risk factors that impact the MTM changes in equity tranche, we put this knowledge to work to analyze two instances in 2008 in which we experienced significant spread widening in equity tranche. Both examples show that a good understanding of the risks that drive MTM changes in CDS tranches is critical in making informed trading decisions. In Chapter Four we focus on two topics: Portfolio Stratification and Index Selection. While portfolio stratification helps us better understand the composition of a portfolio, index selection shows us which indices are more suitable in hedging long bespoke positions. In stratifying a portfolio we define Class-A as the widest credits, Class-B as the middle tier, and Class-C as the tightest credits in a credit portfolio. By portfolio stratification we show that Class-A has significant impact on the overall portfolio. We use five different risk measures to analyze different properties of the three classes we introduce. The risk measures are Sum of Spreads (SOS), Sigma/Mu, Basis Point Volatility (BPVOL), Skewness, and Kurtosis. For all risk measures we show that there is high correlation between Class-A and the whole portfolio. We also show that it is critical to monitor the risks in Class-A to better understand the spread moves in the overall portfolio. In the second part of Chapter Four, we perform analysis to find out which credit index should be used in hedging a long bespoke portfolio. We compare four credit indices for their ability to track the bespoke portfolio on spread levels and on spread changes. Analysis show that CDX.HY and CDX IG indices fits the best to hedge our sample bespoke portfolio in terms of spread levels and spread changes, respectively. Finally, we perform multiple regression analysis using backward selection, forward selection, and stepwise regression methods to find out if we should use multiple indices in our hedging practices. Multiple regression analysis show that CDX.HY and CDX.IG are the best candidates to hedge the sample bespoke portfolio we introduced.

This paper explores the relationship between presidential elections and sovereign credit default swap (CDS) returns, as well as, equity returns in the Latin American countries, Argentina, Brazil, Chile and Mexico. In particular, this paper tests whether or not presidential elections, which potentially represent political uncertainty and risk, affect sovereign CDS returns. I also analyze stock returns during the elections of each country to establish benchmarks that I compare to the CDS returns. Specifically, I evaluate the movement of CDS and equity adjusted returns (i.e. returns measured as deviations from average returns) over 7 presidential elections from 2005 to 2011. The baseline panel regression did not find statistical significance in the dummy election coefficients, but did find significance in the equity intercept coefficient at the 10 percent level. This result suggests that, on average, adjusted equity returns were higher during election periods than adjusted equity returns outside of election periods. I discuss the implications of these results later in the paper.

In a firm level matched sample of 499 firms we examine the information flow between stocks and the credit default swap (CDSs) over a period of January 2004 to December 2008. Our study confirms the general findings of previous studies that the information generally flows from equity market to CDS market. However, for a much smaller number of firms we also find that information also flows from the CDS to its stock. A major advantage of our sample period is that it allows us to examine the information flow before and during the crisis. This paper makes two contributions. We document that the firms for which the information flows from the CDS to its stock increases by almost tenfold during the crisis. The current crisis is often referred as a credit crisis, so this finding is consistent with what is expected of CDSs. The major contribution of this paper is that it identifies the firm specific factors that influence the information flow across the two markets. We show that characteristics such as asset size, profitability, and industry, amongst others, play an important role in determining information flow.

Credit Default Swaps have become a large part of financial markets and recently the center of debate between academics and regulators alike. Transferring the techniques to measure information flow between the CDS market and stock markets presented by Acharya and Johnson (2007), this paper looks at the relationship between a countries sovereign CDS spread level and its predominate stock exchange. Under the back drop of the Greek Credit Crisis in Spring of 2010 I measure contagion effects in the Euro Zone comparing the level of Granger causality significance between the stock and CDS market. I find that the greatest information flow from the CDS market to the stock market is during credit shocks or times of high credit distress. My results also point to the significance of the contagion effect in the CDS market but not in the stock market.

In a firm level matched sample of 499 firms we examine the information flow between stocks and the credit default swap (CDSs) over a period of January 2004 to December 2008. Our study confirms the general findings of previous studies that the information generally flows from equity market to CDS market. However, for a much smaller number of firms we also find that information also flows from the CDS to its stock. A major advantage of our sample period is that it allows us to examine the information flow before and during the crisis. This paper makes two contributions. We document that the firms for which the information flows from the CDS to its stock increases by almost tenfold during the crisis. The current crisis is often referred as a credit crisis, so this finding is consistent with what is expected of CDSs. The major contribution of this paper is that it identifies the firm specific factors that influence the information flow across the two markets. We show that characteristics such as asset size, profitability, and industry, amongst others, play an important role in determining information flow.

信用衍生性商品於近十年來已快速發展，為反映信用風險管理的迫切需求，本篇論文將以實證的方式探討信用衍生性市場。尤其著重在信用違約交換市場，因其佔信用衍生性市場的交易量高達45％。本篇論文分別討論以下二個議題：第一個議題乃在探討股票報酬率的峰態係數與信用違約交換報酬率的關係。第二個議題乃著重探討拉丁美洲國家的信用違約交換對阿根廷事件的反應。 / The development of credit derivatives in the past decade has brought about pronounced innovations in the markets. To reflect dramatic demand in managing credit risk, this thesis dedicates to the empirical world of credit derivatives markets. We especially focus on Credit Default Swaps (CDS) market due to its most widely trading in credit derivatives markets, capturing almost 45% of the market shares. This thesis encompasses two essays related to CDS. In the first essay, we attempt to extend empirical explanation of CDS premiums by considering the excess kurtosis of equity return distribution. As well, we show how copula functions can be applied to specify both the dependence structure and the tail relationship between CDS return and kurtosis of equity distribution. We contribute to the better specification of the dependence structure between the CDS return and the corresponding kurtosis, and provide an illustration of its implication which may be misled using conventional methods. In the second essay, we turn to focus on CDS in emerging markets. Thereby, further policy-oriented applications for governments can be extra induced. We empirically study the correlated default at sovereign level in Latin America region due to the eruption of Argentina debt crisis in 2001. A comprehensive understanding of correlated default at sovereign level is of critical importance in several respects. From the government and IMF point of views, the comovement in sovereign credit default swaps can serve as one of the leading indicators of financial crises. From the perspectives of mutual funds and banks, correlated movement which exists in sovereign CDS spreads is regarded as one of the measures of country risk premium. The findings and the associated methodology can provide useful insights not only to policymakers but also to whoever is interested in credit derivatives markets, particularly in emerging markets. From the methodology point of view, applying a copula method to identify the contagion corresponds to the arguments from Bae et. al. (2003) and Dungey and Tambakis (2003), the further challenge is to develop a model for capturing the nonlinear property.

Chapter 1 develops a model of parallel trading of corporate securities (shares, bonds) and derivatives in which a large trader can sometimes profitably acquire securities and the corporate control rights inherent therein for the sole purpose of reducing the corporation's value and gaining on a net short position in the corporation created through off-setting derivatives. At other times, the large trader profitably takes a net long position in the corporation and exercises its control rights to maximize the corporation's value. This strategy is profitable if and because other market participants cannot observe the large trader's orders and hence cannot predict how the control rights will be exercised. In effect, the large trader is benefitting from trading on private information about payoff uncertainty that the large trader itself creates. This problem is most likely to manifest in transactions that give blocking powers to small minorities, particularly out-of-bankruptcy restructurings and freezeouts, and is bound to become more severe when derivatives trade on an exchange rather than over-the-counter. Chapter 2 investigates in parallel the cross-country determinants of crime and punishment in the largest possible sample of countries with data on homicides, victimization by common crimes (ICVS), incarceration rates, and the death penalty. While models with a small number of plausible covariates predict much of the variation of homicide and incarceration rates between major developed countries, they predict only one seventh of the actual US incarceration rate. Chapter 3 probes into the pervasive correlations between legal origins, modern regulation, and economic outcomes around the world. Where legal origin is exogenous, it is almost perfectly correlated with another set of potentially relevant background variables: the colonial policies of the European powers that spread the "origin" legal systems through the world. The chapter attempts to disentangle these factors by exploiting the imperfect overlap of colonizer and legal origin, and looking at possible channels, such as the structure of the legal system, through which these factors might influence contemporary economic outcomes. It find strong evidence in favor of non-legal colonial explanations for economic growth. For other dependent variables, the results are mixed. / Economics