Exploring the components of credit risk in credit default swaps

Frank J. Fabozzi*, Xiaolin Cheng, Ren Raw Chen

*Corresponding author for this work

Research output: Contribution to journalJournal Article peer-review

40 Scopus citations


In this paper, we test the influence of various fundamental variables on the pricing of credit default swaps. The theoretical determinants that are important for pricing credit default swaps include the risk-free rate, industry sector, credit rating, and liquidity factors. We suggest a linear regression model containing these different variables, especially focusing on liquidity factors. Unlike bond spreads which have been shown to be inversely related to liquidity (i.e., the greater the liquidity, the lower the spread), there is no a priori reason that the credit default swap spread should exhibit the same relationship. This is due to the economic characteristics of a credit default swap compared to a bond. Our empirical result shows that all the fundamental variables investigated have a significant effect on the credit default swap spread. Moreover, our findings suggest that credit default swaps that trade with greater liquidity have a wider credit default swap spread.

Original languageEnglish
Pages (from-to)10-18
Number of pages9
JournalFinance Research Letters
Issue number1
StatePublished - 03 2007
Externally publishedYes


  • Bond spreads
  • Credit default swap
  • Credit default swap spread
  • Credit risk


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