Measuring Default Risk Premia from Default Swap Rates and EDFs

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Measuring Default Risk Premia from Default Swap Rates and EDFs

by Antje Berndt of Carnegie Mellon University,
Rohan Douglas of Quantifi LLC,
Darrell Duffie of Stanford University,
Mark Ferguson of Quantifi LLC, and
David Schranz of CIBC

November 15, 2005

Abstract: This paper estimates the price for bearing exposure to U.S. corporate default risk during 2000-2004, based on the relationship between default probabilities, as estimated by Moody's KMV EDFs, and default swap (CDS) market rates. The default-swap data, obtained through CIBC from 39 banks and specialty dealers, allow us to establish a strong link between actual and risk-neutral default probabilities in the three sectors that we analyze: broadcasting and entertainment, healthcare, and oil and gas. We find dramatic variation over time in risk premia, from peaks in the third quarter of 2002, dropping by roughly 50% to late 2003.

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