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Date of Award

9-2013

Document Type

Campus Access

Degree Name

Doctor of Philosophy (PhD)

Degree Program

Isenberg School of Management

First Advisor

Nikunj Kapadia

Second Advisor

Hossein B. Kazemi

Third Advisor

Sanjay K. Nawalkha

Subject Categories

Finance

Abstract

This dissertation attempts to explore three new ways to understand credit spreads in credit default swaps. The first chapter investigates a hypothesis that the VIX in its role as a fear index impacts intermediary and arbitrageur capital, resulting in decreased market integration across credit and equity markets. Hedging of credit default swaps in the equity markets is found to be surprisingly ineffective. On average, hedging reduces the RMSE by 10% and the VaR by 12%. However, a passive hedge kept in place over a period as long as a month is (multifold) more effective than dynamic daily hedging. The VIX and market returns are demonstrated to predict the improvement that occurs over time. It suggests that frictionless structural models are of limited use in explaining changes in credit spreads.

The second chapter attempts to quantify the extent of informed trading versus hedging trading in the CDS market. By examining the relationship between autocorrelation of CDS return and trading activities, I find that an intense trading shock predicts a large momentum in CDS spread for most of firms in my sample, which indicates that informed trading dominates hedging trading in the CDS market according to the theoretical model. The finding is not asymmetric for adverse and favorable news under my measure. However, I do find that the dominance increases ahead of the deteriorating credit conditions and with number of relationship banks in a manner consistent with the theoretical prediction.

Weak condition of investment banks may limit their ability and willingness to take risky intermediary activities when firms try to access to public capital market. Credit spreads of firms may go up due to interruption of supply of credit when the market is not as perfect as indicated in theories. Empirical results in the third chapter show that the financial health condition of book runners in debt offerings has significant adverse impact on credit spreads of 133 non-financial client firms during the period from January 2002 to June 2008. Moreover, this effect is more significant for firms that have greater credit constraints and that have stronger relationship with underwriters.

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