Exploring mispricing in the term structure of CDS spreads

Jarrow, Robert, Li, Haitao, Ye, Xiaoxia and Hu, May 2018, Exploring mispricing in the term structure of CDS spreads, Review of Finance, pp. 1-38, doi: 10.1093/rof/rfy014.

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Title Exploring mispricing in the term structure of CDS spreads
Author(s) Jarrow, Robert
Li, Haitao
Ye, Xiaoxia
Hu, MayORCID iD for Hu, May orcid.org/0000-0002-0998-1592
Journal name Review of Finance
Start page 1
End page 38
Total pages 38
Publisher Oxford University Press
Place of publication Oxford, Eng.
Publication date 2018-05-08
ISSN 1572-3097
1573-692X
Keyword(s) credit default swaps
mispricing
statistical arbitrage
affine models
market-neutral strategy
hedge funds
Summary Based on a reduced-form model of credit risk, we explore mispricing in the credit default swaps (CDS) spreads of North American companies and its economic content. Specifically, we develop a trading strategy using the model to trade out of sample market-neutral portfolios across the term structure of CDS contracts. Our empirical results show that the trading strategy exhibits abnormally large returns, confirming the existence and persistence of a mispricing. The aggregate returns of the trading strategy are positively related to the square of market-wide credit and liquidity risks, indicating that the mispricing is more pronounced when the market is more volatile. When implemented on the Markit data, the strategy shows significant economic value even after controlling for realistic transaction costs.
Notes In-Press
Language eng
DOI 10.1093/rof/rfy014
Field of Research 1501 Accounting, Auditing And Accountability
1502 Banking, Finance And Investment
HERDC Research category C1 Refereed article in a scholarly journal
Copyright notice ©2018, The Authors
Persistent URL http://hdl.handle.net/10536/DRO/DU:30114195

Document type: Journal Article
Collection: Department of Finance
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