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Measuring credit risk: The relation between CDS Spreads, the modified Merton model and credit ratings

Wedin, Johannes LU and Severinsson, Christian (2013) NEKH01 20122
Department of Economics
Abstract
Prior articles and reports have named Credit Default Swap (CDS) spreads as a
plausible indicator of default risk. In this report, the authors present a significant
correlation between CDS spreads and two other more acknowledged methods of
measuring default risk probabilities; the modified Merton model and credit ratings
from the rating institute Moody’s. The tests are implemented by Spearman’s rank
correlation with data obtained between the years 2008 to 2011. The sample is based
on 30 firms in Europe and America, respectively, and is chosen after the number of
outstanding CDS contracts in November 2012. In order to get as accurate results as
possible, the selection of firms are separated into financial and non-financial sectors:
... (More)
Prior articles and reports have named Credit Default Swap (CDS) spreads as a
plausible indicator of default risk. In this report, the authors present a significant
correlation between CDS spreads and two other more acknowledged methods of
measuring default risk probabilities; the modified Merton model and credit ratings
from the rating institute Moody’s. The tests are implemented by Spearman’s rank
correlation with data obtained between the years 2008 to 2011. The sample is based
on 30 firms in Europe and America, respectively, and is chosen after the number of
outstanding CDS contracts in November 2012. In order to get as accurate results as
possible, the selection of firms are separated into financial and non-financial sectors:
five financial and 25 non-financial firms, respectively for each continent. The CDS
spreads are obtained from 5-year maturity contracts and are taken from Thomson
Reuters DataStream. The variables needed to calculate the modified Merton are
obtained from the same source as well as from comprehensive Excel files provided by
professor Aswath Damodaran at NY University. (Less)
Please use this url to cite or link to this publication:
author
Wedin, Johannes LU and Severinsson, Christian
supervisor
organization
course
NEKH01 20122
year
type
M2 - Bachelor Degree
subject
keywords
Credit Default Swaps, CDS spreads, credit ratings, Moody’s, the modified Merton model, risk assessment, measuring credit risk
language
English
id
3458286
date added to LUP
2013-02-13 11:09:47
date last changed
2013-02-13 11:09:47
@misc{3458286,
  abstract     = {Prior articles and reports have named Credit Default Swap (CDS) spreads as a
plausible indicator of default risk. In this report, the authors present a significant
correlation between CDS spreads and two other more acknowledged methods of
measuring default risk probabilities; the modified Merton model and credit ratings
from the rating institute Moody’s. The tests are implemented by Spearman’s rank
correlation with data obtained between the years 2008 to 2011. The sample is based
on 30 firms in Europe and America, respectively, and is chosen after the number of
outstanding CDS contracts in November 2012. In order to get as accurate results as
possible, the selection of firms are separated into financial and non-financial sectors:
five financial and 25 non-financial firms, respectively for each continent. The CDS
spreads are obtained from 5-year maturity contracts and are taken from Thomson
Reuters DataStream. The variables needed to calculate the modified Merton are
obtained from the same source as well as from comprehensive Excel files provided by
professor Aswath Damodaran at NY University.},
  author       = {Wedin, Johannes and Severinsson, Christian},
  keyword      = {Credit Default Swaps,CDS spreads,credit ratings,Moody’s,the modified Merton model,risk assessment,measuring credit risk},
  language     = {eng},
  note         = {Student Paper},
  title        = {Measuring credit risk: The relation between CDS Spreads, the modified Merton model and credit ratings},
  year         = {2013},
}