Credit risk pricing in single name corporate CDS

The paper examines the determinants of the dynamics and term structure of credit default swap (CDS) spreads. I focus on roles of the interest rate risk and default risk. I extract interest rate factors from libor-swap curve, based on affine models. With a large data set, I test a three-factor CDS spread term structure model for 100 companies, using exact matching technique. The factors consist of two interest rate factors and one default risk factor. The estimation shows intricate interaction between interest rate factor and credit risk factor in determining the default process. I find that positive shock of the first interest rate factor will increase subsequent default risk factor, while positive shock on the second interest rate factor will decrease the subsequent default risk factor. In terms of direct effect of interest rate factors on the default process, positive shock on the first interest rate factor will decrease the default arrival rate at the moment, while positive shock on the second interest rate factor will increase the default arrival rate at the moment. Most of the effects of the shocks to interest rate factors will be sent to the default process indirectly through their impact on the subsequent move of the credit risk factor. CDS spreads of high credit rating companies are less responsive to the shocks on default risk than those of low credit rating companies. The work enhances our understanding of the process which underlies the CDS spreads movement and regimes. Such knowledge is essential for CDS pricing, risk measurement and management, hedging the related risk.