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In Rememberance: World Trade Center (WTC)

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Credit Default Swap Spreads and US Financial Market: Investigating some dependence structure

by Hayette Gatfaoui of Groupe ESC Rouen

September 2007

Abstract: Under Basel II framework, credit risk assessment is of high significance in the light of correlation risk. Correlation risk is often envisioned along with business conditions and financial market's impact. We employ copula methodology to identify the dependence structures that may exist between market risk fundamentals and credit risk fundamentals. Considering credit derivative spreads as credit risk fundamentals and market data as market risk determinants, we describe and quantify the asymmetric link prevailing between credit risk and market risk. Credit risk is negatively linked with market price risk whereas it becomes positively linked with market volatility risk. Such patterns give rise to interesting asymmetric dependence structures between both risk sources.

JEL Classification: C16, C32, D81.

Keywords: Archimedean copulas, concordance measures, credit risk, market risk, tail dependence.

Published in: Annals of Finance, Vol. 6, No. 4, (October 2010), pp. 511-535.

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