Equity and credit-default-swap (CDS) markets are in disagreement as to the extent to which asset returns co-move across firms. This suggests market segmentation and casts ambiguity about the ...asset-return correlations underpinning observed prices of portfolio credit risk. The ambiguity could be eliminated by -- currently unavailable -- data that reveal the market valuation of low-probability/large-impact events. At present, judicious assumptions about this valuation can be used to reconcile observed prices with asset-return correlations implied by either equity or CDS markets. These conclusions are based on an analysis of tranche spreads of a popular CDS index, which incorporate a rather small premium for correlation risk.
Type of material - book
Publication and manufacture - Basel (Switzerland) : Bank for International Settlements, 2006
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