A Value-at-Risk Analysis of Credit Default Swaps and Stocks: Evidence from the European and North American Market

Sammanfattning: This thesis analyzes credit and equity risk during the period from September 2006 to September 2014. The sample includes pairs of credit default swap (CDS) spreads and stock prices for 113 European and 93 North American companies. A historical simulation is performed to compute Value-at-Risk (VaR) and Expected Tail Loss (ETL) for a CDS short position and a long position in the respective firm's equity. Five different hypotheses are tested and their results are compared across different time horizons, rating classes and industries. Overall findings provide additional insights into the dynamics of the credit and equity market over the last eight years. This paper finds evidence on debt always being less risky than equity as demonstrated by Merton in 1974. However, interesting deviations Merton's predictions with respect to drivers of debt riskiness are found with respect to the European market in the most recent years. Furthermore, a declining trend in both credit and equity risk is observed, with the former decreasing at a higher pace. A finding on pooled market samples proves that the positive correlation between credit and equity market is stronger for low credit quality firms. Lastly, this paper notices that credit and equity market may react differently with respect to time and/or magnitude for a given industry in different geographical markets.