Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2015:34: Credit-Implied Forward Volatility and Volatility Expectations

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: We show how one can back out implied forward volatility term structures from credit default swap spreads. Such forward stock volatility term structures are useful for instance in forward start option pricing. We find the term structure to be downward-sloping, and the credit market's volatility forecasts tend to vary more across time than across maturities. Long-term volatility expectations, in turn, are found to be low and stable while short-term expectations are higher and more volatile. The volatility expectation’s mean-reversion rate, finally, indicates that the credit market expects volatility shocks in the equity market to last for several years.

Keywords: CDS; implied volatility term structure; forward volatility; forward start options

JEL-codes: G01; G10

17 pages, September 3, 2015

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