Abstract
Purpose - The aim of this paper is to study the impact of equity returns volatility of reference entities on credit-default swap rates using a new dataset from the Japanese market.
Design/methodology/approach - Using a copula approach, the paper models the different relationships that can exist in different ranges of behavior. It studies the bivariate distributions of credit-default swap rates and equity return volatility estimated with GARCH (1,1) and focus on one parameter Archimedean copula.
Findings - First, the paper emphasizes the finding that pairs with higher rating present a weaker dependence coefficient and then, the impact of equity returns volatility on credit-default swap rates is higher for the lowest rating class. Second, the dependence structure is positive and asymmetric indicating that protection sellers ask for higher credit-default swap returns to compensate the higher credit risk incurred by low rating class.
Practical implications - The paper has several practical implications that are of value for financial hedgers and engineers, loan market participants, financial regulators, government regulators, central banks, and risk managers.
Originality/value - The paper also illustrates the potential benefits of equity returns volatility of reference entities as a proxy of default risk. These simplifications could be lifted in future research on this theme.