Understanding the Term Structure of Credit Default Swap Spreads
44 Pages Posted: 18 Sep 2012 Last revised: 22 Jan 2013
Date Written: January 17, 2011
The shape of the term structure of credit default swap (CDS) spreads displays large variations over time and across firms. Consistent with the predictions of structural models of credit risk, we find that the slope of CDS spread term structure increases with firm leverage and volatility, but decreases with the level and the slope of the Treasury yield curve. However, these variables together have rather limited explanatory power for CDS slope and there is a significant common component in the regression residuals. In addition, we find that CDS slope predicts future changes in CDS spreads, even after controlling for the contemporaneous variables that determine changes in CDS spreads according to the structural models. Our results suggest that while structural models are qualitatively useful for understanding the shape of credit term structure, there are missing factors that importantly affect the term structure of CDS spreads.
Keywords: term structure, credit default swap, credit risk, structural models
JEL Classification: G12
Suggested Citation: Suggested Citation