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Modelling dependence structure with Archimedean copulas and applications to the iTraxx CDS index

✍ Scribed by Nader Naifar

Publisher
Elsevier Science
Year
2011
Tongue
English
Weight
797 KB
Volume
235
Category
Article
ISSN
0377-0427

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✦ Synopsis

In this paper we model the dependence structure between credit default swap (CDS) and jump risk using Archimedean copulas. The paper models and estimates the different relationships that can exist in different ranges of behaviour. It studies the bivariate distributions of CDS index spreads and the kurtosis of equity return distribution. To take into account nonlinear relationships and different structures of dependency, we employ three Archimedean copula functions: Gumbel, Clayton, and Frank. We adopt nonparametric estimation of copula parameters and we find an extreme co-movement of CDS and stock market conditions. In addition, tail dependence indicates the extreme co-movements and the potential for a simultaneous large loss in stock markets and a significant default risk. Ignoring the tail dependence would lead to underestimation of the default risk premium.

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