Essays on default contagion in the CDS market

Abstract

This dissertation consists of three essays on credit default swap(CDS) markets. The first essay develops a model for the pricing of credit portfolios with default contagion in the U.S. corporate CDS market. Using sector-wide CDS portfolio spreads, I investigate how the investors collectively assessed about spillover effects within an industry and contagion effects across industries, providing evidence on default contagion during the 2008 global crisis. I find that the systemic credit risk within the financial sector was so contagious that it cause the other sectors` spreads to sharply increase.

The second essay is closely related to the first one in the view of the methodology used. I apply Hawkes-diffusion process to modelling the sovereign CDS spreads during euro-debt crisis. The result shows that the conditional (risk-neutral) probability that big events occur in eurozone substantially increases during the euro-debt crisis even though it stays low during the global financial crisis.

The third essay reports an anomaly that CDS slope negatively predicts future stock returns in the Korea market. I find that equity returns on the bottom-quintile slope portfolio outperform that on the top-quartile slope portfolio by 2\% per month. I fail to explain the abnormal stock returns with traditionally standard asset pricing models such as CAPM and Fama-French model. Furthermore, some analyses conducted shows that the abnormal return cannot be explained by credit risk nor credit risk premium.