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Decomposing European CDS Returns

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  • Antje Berndt
  • Iulian Obreja

Abstract

Nearly half of the variation in European CDS returns is captured by a novel factor that mimics economic catastrophe risk. During the financial crisis of 2007--8, this factor became more important relative to other sources of risk, leading to a shift in the correlation structure of CDS returns. Using equivalent CDS and equity portfolios, we show that while crucial for explaining temporal and cross-sectional variation in CDS returns, the factor plays a lesser role for equity. This is likely due to the limited sensitivity of the equity value at default to whether the event is of systemic or idiosyncratic nature. Copyright 2010, Oxford University Press.

Suggested Citation

  • Antje Berndt & Iulian Obreja, 2010. "Decomposing European CDS Returns," Review of Finance, European Finance Association, vol. 14(2), pages 189-233.
    • Handle: RePEc:oup:revfin:v:14:y:2010:i:2:p:189-233
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    File URL: http://hdl.handle.net/10.1093/rof/rfq004
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