Journal of Risk

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A value-at-risk analysis of credit default swaps

Burkhard Raunig, Martin Scheicher

ABSTRACT

We investigate the risk of holding credit default swaps (CDSs) in the trading book and compare the value-at-risk (VaR) of a CDS position with the VaR for investing in the respective firm's equity using a sample of CDS-stock price pairs for eighty-six actively traded firms over the period from March 2003 to October 2006.We find that the VaR for a stock usually exceeds the VaR for a position in the same firm's CDS. However, the ratio between CDS and equity VaR is markedly smaller for firms with high credit risk. The ratio also declines for longer holding periods. We also observe a positive correlation between CDS and equity VaR. Panel regressions suggest that our findings are consistent with the qualitative predictions of the Merton model of 1974.

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