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Credit Securitisations and Derivatives: Challenges for the Global Markets by Harald Scheule, Daniel Rösch

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15

CDS Industrial Sector Indices, Credit and Liquidity Risk

Monica Billio1 Massimiliano Caporin2 Loriana Pelizzon1 Domenico Sartore1

1Università Ca’ Foscari Venezia

2Università di Padova

15.1 INTRODUCTION

Is sector credit risk primarily an industry-specific type of risk? Or is sector credit risk driven primarily by common factors? How stable is this relationship? Understanding the nature of industrial sector's credit risk is of key importance given the large and rapidly increasing size of the corporate bond and CDS markets. Furthermore, the nature of the industrial sector's credit risk directly affects the ability of financial market participants to diversify the risk of debt portfolios.

However, despite the importance of CDS in the financial markets, relatively little research about the sources of commonality of these financial products has appeared in the literature.

This chapter investigates these issues using four different methodologies. We first perform a simple dynamic correlation analysis. Second, we use principal component analysis to estimate the number and importance of common factors driving the changes in the CDS indexes. Third, we consider the Exceedence Correlation (EC) of Longin and Solnik (2001) to investigate the heterogeneity of the exposures to different observable factors. Fourth, we perform a quantile regression to investigate the heterogeneity of the exposures among different states of the common factors. We use an extensive database of Credit Derivatives ...

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