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A Study on the CDS Implied Q-P ratio

  • Journal of Insurance and Finance
  • 2017, 28(2), pp.99-132
  • DOI : 10.23842/jif.2017.28.2.004
  • Publisher : Korea Insurance Research Institute
  • Research Area : Social Science > Business Management
  • Received : March 29, 2017
  • Accepted : May 18, 2017
  • Published : May 31, 2017

Jungmu Kim 1 Yuen Jung Park 2

1영남대학교
2한림대학교

Accredited

ABSTRACT

This study investigates both the cross-sectional properties and the time-series determinants of Q-P ratio implied in Korean corporate credit default swap (CDS) spreads. We obtained the maximum likelihood estimates of the risk neutral default intensity model with the assumption of mean-reversion log normal process. As a result, the Q-P ratio, defined as the default probability under Q-measure divided by the default probability under P- measure, is lower for firms with the higher credit rating, consistently with the previous results in the U.S. corporate CDS market. It can be interpreted as that the investors in the CDS market require the lower risk premium for the uncertainty of future default probability related to the arrival of the unexpected credit events to firms with the higher credit rating. Moreover, we demonstrate that the time series variations of the Q-P ratio are positively related with the Korean sovereign CDS spread and negatively related with the U.S. VIX. Specially, the changes in the Korean sovereign CDS spread account for the approximately 95% of the changes in the first component of the Q-P ratio. These results imply that default risk and risk premium of Korean firms substantially depend on those of Korean government. Therefore, it suggests that Korean corporate CDS traders should monitor the credit risk changes of Korean government as systematic risk factor.

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