Bayesian dynamic linear modeling for exploring the impact of recent financial crisis on Japan Credit Default Swap market

Authors:
Jiashen You;Tomohiro Ando
Affiliations:
Department of Statistics, University of California Los Angeles, 8125 Math Sciences, Box 951554, Los Angeles, CA 90034, USA;Graduate School of Business Administration, Keio University, 4-1-1 Hiyoshi, Kohoku-ku, Yokohama-shi, Kanagawa 223-8526, Japan
Venue:
Expert Systems with Applications: An International Journal
Year:
2012

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Abstract

This paper investigates the effects of recent subprime financial crisis on Japan Credit Default Swap (CDS) market. We first analyze the relationship between the log return series of the reference rates of a CDS contract and the hazard rate. This provides a theoretical foundation for the use of correlation of the log CDS returns as a representation of credit risk correlation. In the dynamic Bayesian linear modeling framework, we consider an algorithm that allow us to obtain dynamic Bayesian updates for the correlation among the reference rates of an underlying CDS contract. Data from the Japan CDS market is analyzed using the proposed methodology. An empirical analyses on the data segmented by different economic environments are carried out. Results indicate that the estimated implied default correlation captures market structure very well and provides useful information for credit risk management.