Shi, Y. , Chen, D., Guo, B., Xu, Y. and Yan, C. (2022) The information content of CDS implied volatility and associated trading strategies. International Review of Financial Analysis, 83, 102295. (doi: 10.1016/j.irfa.2022.102295)
Text
274873.pdf - Accepted Version Available under License Creative Commons Attribution Non-commercial No Derivatives. 1MB |
Abstract
Using the theoretical link between put options and credit default swaps (CDS) in a very general setting, we develop a robust measure of CDS implied volatility (CIV) that captures the information content of CDS markets. Specifically, we use the unit recovery claim to bridge CDS and deep out-of-the-money put options of the same firm and then back out CIV via the binomial tree. Our CIV measure strongly co-moves with the option implied volatility (OIV), with a correlation coefficient of 0.8. Based on the standardized difference between CIV and OIV, we construct CDS and option trading strategies. Without taking transaction costs into account, the long-short CDS trading strategy achieves an annualized return of 58.29% and a Sharpe ratio of 2.97, which can not be explained by non-parametric skewness and volatility risk.
Item Type: | Articles |
---|---|
Status: | Published |
Refereed: | Yes |
Glasgow Author(s) Enlighten ID: | Shi, Dr Yukun |
Authors: | Shi, Y., Chen, D., Guo, B., Xu, Y., and Yan, C. |
College/School: | College of Social Sciences > Adam Smith Business School > Accounting and Finance |
Journal Name: | International Review of Financial Analysis |
Publisher: | Elsevier |
ISSN: | 1057-5219 |
ISSN (Online): | 1873-8079 |
Published Online: | 11 July 2022 |
Copyright Holders: | Copyright © 2022 Elsevier Inc. |
First Published: | First published in International Review of Financial Analysis 83: 102295 |
Publisher Policy: | Reproduced in accordance with the publisher copyright policy |
University Staff: Request a correction | Enlighten Editors: Update this record