Trading of credit indices

: behaviour analysis

Abstract

This document was written with the aim of analysing the behaviour of the Credit Default Swaps market, particularly the trading of Credit Indices. To do so it was chosen the following index: iTraxx Financials Senior, with 5-year maturity (European index, originally created by Markit). The econometric analysis is conducted with the help of a T-GARCH model. On a first level it is investigated if the index spreads reflect the perceived credit risk of market participants. Past studies point out that the spreads of Credit Indices are in fact a good measure to understand the credit quality of an entity. This question is address by testing if the volatility of the index returns has the following properties: Volatility Clustering, Long Memory and Excess Kurtosis (these are typically present on financials time series). In fact, an increase of the Spread is perceived as a deterioration of the reference entity credit quality. On a second level and after a preliminary analysis it is tested if these returns have the following characteristics: Risk Aversion and Leverage Effects (these are present on the stock market, for example). In order to do so it is estimated a T-GARCH model. It is concluded that investors who trade in Credit Indices market are not risk averse and they do not fear “bad news” about the financial markets. In fact, these findings are in line with the theory that states that investors tend to win with the presence of these “bad news”.

Date of Award	6 Jul 2016
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Carlos Manuel Ferreira dos Santos (Supervisor)