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CDS Inferred Stock Volatility
Author(s) -
Guo Biao
Publication year - 2016
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.21768
Subject(s) - volatility (finance) , volatility smile , downside risk , volatility swap , implied volatility , economics , financial economics , stock (firearms) , equity (law) , econometrics , variance swap , volatility risk premium , portfolio , engineering , mechanical engineering , political science , law
Both CDS and out‐of‐money put option can protect investors against downside risk, so they are related while not being mutually replaceable. This study provides a straightforward linkage between corporate CDS and equity option by inferring stock volatility from CDS spread and, thus, enables a direct analogy with the implied volatility from option price. I find CDS inferred volatility (CIV) and option implied volatility (OIV) are complementary, both containing some information that is not captured by the other. CIV dominates OIV in forecasting stock future realized volatility. Moreover, a trading strategy based on the CIV–OIV mean reverting spreads generates significant risk‐adjusted return. These findings complement existing empirical evidence on cross‐market analysis. © 2016 Wiley Periodicals, Inc. Jrl Fut Mark 36:745–757, 2016