Rita D’Ecclesia
Professor, Sapienza University of Rome, Italy.
Rosella Castellano
University of Macerata, Italy.Credit Quality and CDS’ Volatility: The Key Signal
This paper investigates the role of CDS volatility in providing
information concerning the credit quality of the company. In Castellano
D’Ecclesia (2011) a first analysis of how CDS quotes respond to rating
announcements is provided and it is shown that market participants do
not rely much on Rating Agencies announcements, especially in periods
of very high volatility, i.e. during the financial crisis. A more accurate
analysis of the CDS’s volatility is provided using an EGARCH(1,1)
approach. The event study methodology with an Exponential
Generalized Autoregressive Conditional Heteroschedasticity model is
then applied to CDS quotes of European and US companies over the
period 2004-2009. The results provide a more accurate understanding of
the market behavior in presence of news released by Rating Agencies.
In presence of downgrading market participants anticipate the event in
most of the cases and CDS quotes show statistically significant positive
difference from the benchmark.