Analyzing Credit Risk in Default Swap Transaction Data : Is Fixed-Income Markets’ Information Sufficient to Evaluate Credit Risk?

We investigate the influence of various variables on credit default swap transaction data. Credit derivatives are arguably a superior proxy to credit risk than bond spreads. The variables considered include fixed-income as well as equity markets data. We thus provide an international analysis of corporate credit risk, and some results on sovereign risk. Simple models explain a significant portion of the cross-sectional variation in our sample (with R2 reaching 80%). We uncover important behavioral differences between high rated and low rated, US and non US, corporate and sovereign underlyings. We also find evidence of momentum. Contrarily to earlier results, equity market information matters for both high and low ratings, albeit in different ways. We implement a spread-based reduced-form model. Equity information explains close to 50% of the errors obtained. Overall, strong results show the importance of considering equity market information beyond ratings and even bond spreads when pricing credit risk.