Price convergence between credit default swap and put option : New evidence

Chan, Ka Kei and Kolokolova, Olga and Lin, Ming-Tsung and Poon, Ser Huang (2023) Price convergence between credit default swap and put option : New evidence. Journal of Empirical Finance, 72. pp. 188-213. ISSN 0927-5398

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Credit default swaps and deep out-of-the-money put options can be used for credit protection, but these markets are not perfectly integrated, leading to different implied hazard rates. The differences in the implied hazard rates are linked to deviations between consensus rating-based hazard rate curves in the two markets, and a residual component related to market frictions. We show that both components diminish over time, but their convergence is asynchronous. A trading strategy based on a joint signal from the curve and residual differences outperforms a conventional trading approach that relies on the absolute differences between the implied hazard rates. Hedge funds are likely to exploit within-market inefficiencies and deviations from rating-based curve, but they do not seem to profit from market segmentation.

Item Type:
Journal Article
Journal or Publication Title:
Journal of Empirical Finance
Uncontrolled Keywords:
?? convergencecredit default swap (cds)deep out-of-the-money put optionmarket segmentationtrading strategyfinanceeconomics and econometrics ??
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Deposited On:
08 Sep 2023 12:15
Last Modified:
16 Jul 2024 00:10