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Ambiguity, Volatility, and Credit Risk

Author

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  • Patrick Augustin
  • Yehuda Izhakian
  • Stijn Van Nieuwerburgh

Abstract

We explore the implications of ambiguity for the pricing of credit default swaps (CDSs). A model of heterogeneous investors with independent preferences for ambiguity and risk shows that, because CDS contracts are assets in zero net supply, the net credit risk exposure of the marginal investor determines the sign of the impact of ambiguity on CDS spreads. We find that ambiguity has an economically significant negative impact on CDS spreads, on average, suggesting that the marginal investor is a net buyer of credit protection. A 1-standard-deviation increase in ambiguity is estimated to decrease CDS spreads by approximately 6%.

Suggested Citation

  • Patrick Augustin & Yehuda Izhakian & Stijn Van Nieuwerburgh, 2020. "Ambiguity, Volatility, and Credit Risk," The Review of Financial Studies, Society for Financial Studies, vol. 33(4), pages 1618-1672.
    • Handle: RePEc:oup:rfinst:v:33:y:2020:i:4:p:1618-1672.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhz082
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    Citations

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    Cited by:

    1. Czech, Robert, 2021. "Credit default swaps and corporate bond trading," Journal of Financial Intermediation, Elsevier, vol. 48(C).
    2. Gao, Feng & Li, Yubin & Wang, Xinjie & Zhong, Zhaodong (Ken), 2021. "Corporate social responsibility and the term structure of CDS spreads," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 74(C).
    3. Takao Asano & Xiaojing Cai & Ryuta Sakemoto, 2023. "Time-varying ambiguity shocks and business cycles," KIER Working Papers 1094, Kyoto University, Institute of Economic Research.
    4. Ugolini, Andrea & Reboredo, Juan C. & Ojea-Ferreiro, Javier, 2024. "Is climate transition risk priced into corporate credit risk? Evidence from credit default swaps," Research in International Business and Finance, Elsevier, vol. 70(PB).
    5. Hasan, Iftekhar & Marra, Miriam & To, Thomas Y. & Wu, Eliza & Zhang, Gaiyan, 2023. "COVID-19 Pandemic and Global Corporate CDS Spreads," Journal of Banking & Finance, Elsevier, vol. 147(C).
    6. Asano, Takao & Cai, Xiaojing & Sakemoto, Ryuta, 2024. "Currency portfolios and global foreign exchange ambiguity," Finance Research Letters, Elsevier, vol. 65(C).
    7. Qiang Chen & Yu Han & Ying Huang, 2024. "Market‐wide overconfidence and stock returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(1), pages 3-26, January.
    8. Ayoub, Mahmoud & Qadan, Mahmoud, 2024. "Ambiguity and risk in the oil market," Economic Modelling, Elsevier, vol. 132(C).
    9. Fu, Ruonan & Melenberg, Bertrand & Schweizer, Nikolaus, 2023. "Comment on “A theoretical foundation of ambiguity measurement” [J. Econ. Theory 187 (2020) 105001]," Journal of Economic Theory, Elsevier, vol. 207(C).
    10. Yehuda Izhakian & David Yermack & Jaime F. Zender, 2022. "Ambiguity and the Tradeoff Theory of Capital Structure," Management Science, INFORMS, vol. 68(6), pages 4090-4111, June.
    11. Massari, Filippo & Newton, Jonathan, 2020. "When does ambiguity fade away?," Economics Letters, Elsevier, vol. 194(C).
    12. Ben-Rephael, Azi & Cookson, J. Anthony & izhakian, yehuda, 2022. "Do I Really Want to Hear The News? Public Information Arrival and Investor Beliefs," SocArXiv ud7yw, Center for Open Science.
    13. Chen, Qiang & Han, Yu, 2023. "Options market ambiguity and its information content," Journal of Financial Markets, Elsevier, vol. 64(C).
    14. Ben-Rephael, Azi & Cookson, J. Anthony & izhakian, yehuda, 2022. "Trading, Ambiguity and Information in the Options Market," SocArXiv ewunv, Center for Open Science.
    15. Oh, Byungmin & Park, Haerang & Joe, Denis Yongmin, 2024. "Determinants of credit default swap spread changes: The sell-side perspective," Finance Research Letters, Elsevier, vol. 61(C).
    16. Shust, Efrat, 2024. "The ambiguous December," Finance Research Letters, Elsevier, vol. 61(C).

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