Advanced

Alternative Determinants of Credit Premia: Altman's Z and the Empirical Components Approach

Thorburn, Charles (2006)
Department of Economics
Abstract
This paper conducts an empirical study of the determinants of credit default swap (CDS) prices. By using a new set of CDS quotes and explanatory variables for thirty major corporations, a set of linear panel data regressions are performed. The study confirms earlier research where risk free interest rate, volatility and leverage are found to be highly significant. In addition to this, a new variable, Altman’s Z-score, is introduced and found to have a significant effect on the CDS price. The Z-score is introduced as a potential substitute for leverage and the two variables are hence compared in terms of significance and explanatory power. It is found that the Z-score is inferior to leverage in explaining the changes of the CDS price for... (More)
This paper conducts an empirical study of the determinants of credit default swap (CDS) prices. By using a new set of CDS quotes and explanatory variables for thirty major corporations, a set of linear panel data regressions are performed. The study confirms earlier research where risk free interest rate, volatility and leverage are found to be highly significant. In addition to this, a new variable, Altman’s Z-score, is introduced and found to have a significant effect on the CDS price. The Z-score is introduced as a potential substitute for leverage and the two variables are hence compared in terms of significance and explanatory power. It is found that the Z-score is inferior to leverage in explaining the changes of the CDS price for one firm over time. However, for inter-firm cross-sectional analysis, the Z-score outperforms leverage. Hence, the conclusion is that Altman’s Z-score and leverage have different strengths and that the variable to use is best chosen considering the type of study at hand. (Less)
Please use this url to cite or link to this publication:
@misc{1337128,
  abstract     = {This paper conducts an empirical study of the determinants of credit default swap (CDS) prices. By using a new set of CDS quotes and explanatory variables for thirty major corporations, a set of linear panel data regressions are performed. The study confirms earlier research where risk free interest rate, volatility and leverage are found to be highly significant. In addition to this, a new variable, Altman’s Z-score, is introduced and found to have a significant effect on the CDS price. The Z-score is introduced as a potential substitute for leverage and the two variables are hence compared in terms of significance and explanatory power. It is found that the Z-score is inferior to leverage in explaining the changes of the CDS price for one firm over time. However, for inter-firm cross-sectional analysis, the Z-score outperforms leverage. Hence, the conclusion is that Altman’s Z-score and leverage have different strengths and that the variable to use is best chosen considering the type of study at hand.},
  author       = {Thorburn, Charles},
  keyword      = {credit derivatives,credit default swap,default risk,CDS,kreditderivat,altman,Economics, econometrics, economic theory, economic systems, economic policy,Nationalekonomi, ekonometri, ekonomisk teori, ekonomiska system, ekonomisk politik},
  language     = {eng},
  note         = {Student Paper},
  title        = {Alternative Determinants of Credit Premia: Altman's Z and the Empirical Components Approach},
  year         = {2006},
}