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Empirical Essays on Financial Economics

Degrér, Henrik LU (2004) In Lund Economic Studies
Abstract
In the first essay of this thesis we develop a model for calculating the net expected value of a swap agreement subject to dual-default risk. The main explanatory variable for the net expected return of a swap is the default intensity of each party measured by the credit rating of the firm. We derive the net expected return of the swap as a function of the credit rating of the firm receiving the fixed interest rate and credit rating of the firm receiving the floating interest rate. This net expected return will also depend on the stochastic process assumed for the short-term interest rate as well as the initial interest rate, the time to maturity and the time between settlements. We calibrate a counting process, using historical data, for... (More)
In the first essay of this thesis we develop a model for calculating the net expected value of a swap agreement subject to dual-default risk. The main explanatory variable for the net expected return of a swap is the default intensity of each party measured by the credit rating of the firm. We derive the net expected return of the swap as a function of the credit rating of the firm receiving the fixed interest rate and credit rating of the firm receiving the floating interest rate. This net expected return will also depend on the stochastic process assumed for the short-term interest rate as well as the initial interest rate, the time to maturity and the time between settlements. We calibrate a counting process, using historical data, for each firm. These processes represent the time to bankruptcy for each firm. We also calibrate a CIR model for the short-term interest rate using historical data. These calibrated processes are used in Monte Carlo simulations to derive the net expected return of the swap. We find that the possibility of default has a large effect on the contract.



In the second essay we further investigate the swap pricing model used before. In order to obtain accurate net expected returns of swap agreements under dual-default risk, it is important to model the process governing the interest rates correctly. In this chapter we present and evaluate different term structure models for the interest rate. The conclusion, of this essay, is that the net expected value of the swap is greatly influenced by the choice of term structure model. The differences in the net expected value of the swap between the investigated term structure models are considerable



In the third essay of this thesis we analyze the empirical relationship between credit risk and the price of a swap agreement. Our hypothesis is that companies do take the credit risk into consideration when entering swap agreements, either directly through the price or via some form of credit rationing. We have obtained a unique dataset from two Swedish companies containing all relevant information on their swap agreements, as well as full counterparty information. Using this dataset we are able to empirically test our hypothesis



In the final essay we develop an index for measuring the state of the Swedish economy with financial variables. Instead of using relative deviations from a specified date or level of the exchange rate, interest rate, house prices, and stock prices, as in a standard Financial Conditions Index (FCI), we use deviations from estimated (partial) equilibrium values. This framework makes it possible to differentiate between changes in the variables derived from underlying macroeconomic factors and changes that alter the monetary conditions in an economy. The deviations between actual and equilibrium values for the included variables are weighted together, using a VAR approach, in order to obtain an economic conditions index. (Less)
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author
opponent
  • Professor Berglund, Tom, Svenska Handelshögskolan i Helsingfors
organization
publishing date
type
Thesis
publication status
published
subject
keywords
Swap Agreements, Default Risk, Economic Conditions Index, Finansiering, Financial science, Term Structure of Interest Rates
in
Lund Economic Studies
pages
146 pages
publisher
Lund University
defense location
EC3:211 Holger Crafoords Ekonomicenter
defense date
2004-04-22 10:15
ISSN
0460-0029
language
English
LU publication?
yes
id
76b0259b-f153-44d2-bf47-15f33e1f0591 (old id 466839)
date added to LUP
2007-09-25 20:32:26
date last changed
2016-09-19 08:44:55
@phdthesis{76b0259b-f153-44d2-bf47-15f33e1f0591,
  abstract     = {In the first essay of this thesis we develop a model for calculating the net expected value of a swap agreement subject to dual-default risk. The main explanatory variable for the net expected return of a swap is the default intensity of each party measured by the credit rating of the firm. We derive the net expected return of the swap as a function of the credit rating of the firm receiving the fixed interest rate and credit rating of the firm receiving the floating interest rate. This net expected return will also depend on the stochastic process assumed for the short-term interest rate as well as the initial interest rate, the time to maturity and the time between settlements. We calibrate a counting process, using historical data, for each firm. These processes represent the time to bankruptcy for each firm. We also calibrate a CIR model for the short-term interest rate using historical data. These calibrated processes are used in Monte Carlo simulations to derive the net expected return of the swap. We find that the possibility of default has a large effect on the contract.<br/><br>
<br/><br>
In the second essay we further investigate the swap pricing model used before. In order to obtain accurate net expected returns of swap agreements under dual-default risk, it is important to model the process governing the interest rates correctly. In this chapter we present and evaluate different term structure models for the interest rate. The conclusion, of this essay, is that the net expected value of the swap is greatly influenced by the choice of term structure model. The differences in the net expected value of the swap between the investigated term structure models are considerable<br/><br>
<br/><br>
In the third essay of this thesis we analyze the empirical relationship between credit risk and the price of a swap agreement. Our hypothesis is that companies do take the credit risk into consideration when entering swap agreements, either directly through the price or via some form of credit rationing. We have obtained a unique dataset from two Swedish companies containing all relevant information on their swap agreements, as well as full counterparty information. Using this dataset we are able to empirically test our hypothesis<br/><br>
<br/><br>
In the final essay we develop an index for measuring the state of the Swedish economy with financial variables. Instead of using relative deviations from a specified date or level of the exchange rate, interest rate, house prices, and stock prices, as in a standard Financial Conditions Index (FCI), we use deviations from estimated (partial) equilibrium values. This framework makes it possible to differentiate between changes in the variables derived from underlying macroeconomic factors and changes that alter the monetary conditions in an economy. The deviations between actual and equilibrium values for the included variables are weighted together, using a VAR approach, in order to obtain an economic conditions index.},
  author       = {Degrér, Henrik},
  issn         = {0460-0029},
  keyword      = {Swap Agreements,Default Risk,Economic Conditions Index,Finansiering,Financial science,Term Structure of Interest Rates},
  language     = {eng},
  pages        = {146},
  publisher    = {Lund University},
  school       = {Lund University},
  series       = {Lund Economic Studies},
  title        = {Empirical Essays on Financial Economics},
  year         = {2004},
}