Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2014:34: Credit-Implied Equity Volatility – Long-Term Forecasts and Alternative Fear Gauges

Hans Byström ()
Additional contact information
Hans Byström: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: This study discusses how to compute and forecast long-term stock return volatilities, typically with a 5-year horizon or longer, using credit derivatives, and how such volatilities can be used in different areas ranging from the valuation of employee stock options and other long-term derivatives to the construction of market-based fear gauges in selected countries or market segments. In the empirical part of the paper I focus on the European financial sector and find the credit-implied volatilities and fear gauges to behave well. The forecasting accuracy of the credit-implied volatilities is found to be better than that of horizon-matched historical volatilities.

Keywords: credit default swaps; implied volatility; CreditGrades; VIX; fear gauge; long-term forecast

JEL-codes: G10

46 pages, September 4, 2014

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