Date of Original Version

11-2009

Type

Article

Published In

Review of Finance (2010) 14 (2): 189-233.

Abstract or Description

Nearly half of the variation in European CDS returns is captured by a novel factor that mimics economic catastrophe risk. During the financial crisis of 2007–8, this factor became more important relative to other sources of risk, leading to a shift in the correlation structure of CDS returns. Using equivalent CDS and equity portfolios, we show that while crucial for explaining temporal and cross-sectional variation in CDS returns, the factor plays a lesser role for equity. This is likely due to the limited sensitivity of the equity value at default to whether the event is of systemic or idiosyncratic nature.

DOI

10.1093/rof/rfq004

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