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    Exploring mispricing in the term structure of CDS spreads

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    Ye_Review_of_Finance.pdf (793.6Kb)
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    Publication date
    2019-02
    Author
    Jarrow, R.
    Li, H.
    Ye, Xiaoxia
    Hu, M.
    Keyword
    Credit default swaps
    Mispricing
    Statistical arbitrage
    Affine models
    Market-neutral strategy
    Hedge funds
    Rights
    (c) The Author(s) 2018. Published by Oxford University Press on behalf of the European Finance Association. All rights reserved. For permissions, please email: journals.permissions@oup.com
    Peer-Reviewed
    Yes
    
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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.
    URI
    http://hdl.handle.net/10454/15730
    Version
    Accepted Manuscript
    Citation
    Jarrow R, Li H, Ye X et al (2018) Exploring mispricing in the term structure of CDS spreads. Review of Finance. 23(1): 161-198.
    Link to publisher’s version
    https://doi.org/10.1093/rof/rfy014
    Type
    Article
    Collections
    Management and Law Publications

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