Empirical Analysis of Credit Risk Regime Switching and Temporal Conditional Default Correlation in Credit Default Swap Valuation: The Market liquidity effect

In this paper, we extend the debate concerning Credit Default Swap valuation to include time varying correlation and co-variances. Traditional multi-variate techniques treat the correlations between covariates as constant over time; however, this view is not supported by the data. Secondly, since financial data does not follow a normal distribution because of its heavy tails, modeling the data using a Generalized Linear model (GLM) incorporating copulas emerge as a more robust technique over traditional approaches. This paper also includes an empirical analysis of the regime switching dynamics of credit risk in the presence of liquidity by following the general practice of assuming that credit and market risk follow a Markov process. The study was based on Credit Default Swap data obtained from Bloomberg that spanned the period January 1st 2004 to August 08th 2006. The empirical examination of the regime switching tendencies provided quantitative support to the anecdotal view that liquidity decreases as credit quality deteriorates. The analysis also examined the joint probability distribution of the credit risk determinants across credit quality through the use of a copula function which disaggregates the behavior embedded in the marginal gamma distributions, so as to isolate the level of dependence which is captured in the copula function. The results suggest that the time varying joint correlation matrix performed far superior as compared to the constant correlation matrix; the centerpiece of linear regression models.

US Corporate Default Swap Valuation: The Market Liquidity Hypothesis and Autonomous Credit Risk

This paper develops a reduced form three-factor model which includes a liquidity proxy of market conditions which is then used to provide implicit prices. The model prices are then compared with observed market prices of credit default swaps to determine if swap rates adequately reflect market risks. The findings of the analysis illustrate the importance of liquidity in the valuation process. Moreover, market liquidity, a measure of investors. willingness to commit resources in the credit default swap (CDS) market, was also found to improve the valuation of investors. autonomous credit risk. Thus a failure to include a liquidity proxy could underestimate the implied autonomous credit risk. Autonomous credit risk is defined as the fractional credit risk which does not vary with changes in market risk and liquidity conditions.

Liquidity Constraint and Child Labor In India: Is Market Really Incapable Of Eradicating It From Wage-Labor Households?

One way to measure the lower steady state equilibrium outcome in human capital development is the incidence of child labor in most of the developing countries. With the help of Indian household level data in an overlapping generation framework, we show that production loans under credit rationing are not optimally extended towards firms because of issues with adverse selection. More stringent rationing in the credit market creates a distortion in the labor market by increasing adult wage rate and the demand for child labor. Lower availability of funds under stringent rationing coupled with increased demand for loans induces the high risk firms to replace adult labor by child labor. A switch of regime from credit rationing to revelation regime can clear such imperfections in the labor market. The equilibrium higher wage rate elevates the household consumption to a significantly higher level than the subsistence under credit rationing and therefore higher level of human capital development is assured leading to no supply of child labor.