The Impact of Stock Returns Volatility on Credit Default Swap Rates: A copula study

by Fathi Abid of the University of Sfax, and
Nader Naifar of the University of Sfax

May 21, 2005

Abstract: The aim of this paper is to study the impact of Stock returns volatility of reference entities on credit default swap rates using a new dataset from the Japanese market. The majority of empirical research suggests the inadequacy of multinormal distribution and then the failure of methods based on correlation for measuring the structure of dependency. Using a copula approach, we can model the different relationships that can exist in different ranges of behavior. We study the bivariate distributions of credit default swap rates and the measure of stock return volatility estimated with GARCH (1,1) and focus on one parameter Archimedean copula. Starting from the empirical rank correlation statistics (Kendall's tau and Spearman's rho), we estimate the parameter values of each copula function presented in our study. Then, we choose the appropriate Archimedean copula that better fit to our data. We emphasize the finding that pairs with higher rating present a weaker dependence coefficient and then, the impact of stock return volatility on credit default swap rates is higher for the lowest rating class.

JEL Classification: C13, C14, C19.

Keywords: Copulas functions, credit default swap, volatility, bivariate distribution, Nonparametric estimation, Semi-parametric estimation.

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