Evaluating Credit Default Swap spreads using the CreditGrades model - A study on European non-financial firms

Abstract: In our paper, we analyse Credit Default Swaps (CDSs) for 67 European non-financial companies between December 2004 and December 2014, focusing on the five-year maturity corporate CDS spreads. The period of analysis is divided into three sub-periods; before the financial crisis, during the global financial crisis and the European sovereign debt crisis. The CreditGrades model is used to estimate CDS spreads where the volatility is estimated by two different methods; a Moving Average (MA) and a Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model. The empirically observed spreads are compared with the predicted CDS spreads. Our findings suggest that the estimation of volatility with the MA approach performs better than the GARCH model. Furthermore, trading strategies are implemented seeking positive returns on the CDS market. The best performing strategies are based on the autocorrelation of the observed CDS spreads.