Scaling the Volatility of Credit Spreads: Evidence from Australian Dollar Eurobonds
Nanyang Technological University, Department of Banking and Finance Working Paper No. 99-03
36 Pages Posted: 13 Dec 1999
Date Written: April 1999
Many asset pricing models require an annualised risk coefficient which is determined by the linear rescaling of the variance from other time intervals. However, this approach may not be appropriate for dependent time series. This paper investigates the scaling relationships for daily credit spreads, from January 1986 to May 1998, between AAA, AA and A rated Australian dollar denominated Eurobonds with maturities of 2, 5, 7 and 10 years. We find evidence of a term structure and co-movement in credit spreads by maturity. We also find the credit spread return series were time variant, leptokurtic, autocorrelated and exhibited different degrees of negative long-term dependence. The series all displayed similar scaling properties with the estimated standard deviation, based upon a scaling at the square root of time, significantly underestimating the actual level of risk predicted from a normal distribution. These results have implications for credit spread derivatives.
JEL Classification: C1, F3, G1
Suggested Citation: Suggested Citation