Exploring Mispricing in the Term Structure of CDS Spreads

Jarrow, Robert, Li, Haitao, Ye, X ORCID: 0000-0002-5024-6186 and Hu, May (2019) Exploring Mispricing in the Term Structure of CDS Spreads. Review of Finance, 23 (1). pp. 161-198.

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Abstract

Based on a reduced-form model of credit risk, we explore mispricing in the CDS spreads of North American companies and its economic content. Specifically, we develop a trading strategy using the model to trade out of sample market-neutral portfolios across the term structure of CDS contracts. Our empirical results show that the trading strategy exhibits abnormally large returns, confirming the existence and persistence of a mispricing. The aggregate returns of the trading strategy are positively related to the square of market-wide credit and liquidity risks, indicating that the mispricing is more pronounced when the market is more volatile. When implemented on the Markit data, the strategy shows significant economic value even after controlling for realistic transaction costs.

Item Type:	Article
Additional Information:	Source info: Forthcoming, Review of Finance
Uncontrolled Keywords:	fixed income and credit risk, investment strategies and anomalies
Depositing User:	Symplectic Admin
Date Deposited:	08 Jun 2018 10:31
Last Modified:	19 Jan 2023 01:32
DOI:	10.1093/rof/rfy014
Related URLs:	Author Publisher
URI:	https://livrepository.liverpool.ac.uk/id/eprint/3022077