Correlations and linkages in credit risk : an investigation of the credit default swap market during the turmoil

Abstract

This thesis investigates correlations and linkages in credit risk that widely exist in all sectors of the financial markets. The main body of this thesis is constructed around four empirical chapters. I started with extending two main issues focused by earlier empirical studies on credit derivatives markets: the determinants of CDS spreads and the relationship between CDS spreads and bond yield spreads, with a special focus on the effect of the subprime crisis. By having observed that the linear relationship can not fully explain the variation in CDS spreads, the third empirical chapter investigated the dependence structure between CDS spread changes and market variables using a nonlinear copula method. The last chapter investigated the relationship between the CDS spread and another credit spread - the TED spread, in that a MVGARCH model and twelve copulas are set forth including three time varying copulas. The results of this thesis greatly enhanced our understanding about the effect of the subprime crisis on the credit default swap market, upon which a set of useful practical suggestions are made to policy makers and market participants.