The structure and dynamics of European credit and interest rate markets: an empirical analysis

This thesis provides an empirical analysis of European credit and interest rate derivative markets. By employing various econometric methods it looks to further understand the dynamics of these markets. This empirical research is conducted using European credit default swaps both corporate and sovereign and the European interbank deposit rate Euribor and its derivatives over a 13 year sample period 2001 to 2014. The sample period is a very interesting time to look at European nancial markets. The Euro currency and Euribor interest rate are both relatively new markets and since their introduction European nancial markets have been characterised by both stable and crisis periods. The rst part of this thesis looks at the European credit default swap (CDS) market. It investigates the risk return relationship in the CDS market and using a four factor higher moment CAPM model it tests whether CDS returns are commensurate with the level of systematic risk. Results suggest that European corporate CDS returns are commensurate with their level of systematic risk and that the inclusion of higher moments is important in explaining returns. Using European Sovereign CDS names a tractable methodology to model and forecast sovereign CDS term structure is employed. Over the volatile sample period the CDS term structure exhibits various shapes. Our results show that the CDS curve ts the data and slows for the various shapes exhibited by the CDS data including steep, inverted and downward sloping curves. Results show that the applied methodology is successful in forecasting CDS term structure over longer time horizons. The latter half of this thesis examines the Euribor market. It rst focuses on understanding the relationship between the Euribor futures market and the underlying reference rate from both the price discovery and volatility transfer perspective. A signi cant break down in the relationship between the deposit and future market during times of crisis is identi ed. Results suggest that the deposit rate is generally the more informationally e cient market, leading the futures market in price discovery and driving future market volatility through direct volatility spillovers from the deposit market. Lastly this thesis examines the jump characteristics of the 3 month Euribor futures contract and its corresponding futures option contracts. It extracts jump parameters and implied jump parameters using historical futures rates and option prices. Using the estimated jump parameters we use regression analysis to examine the relationship between ECB monetary policy announcements and the jump behaviour of the Euribor rate. The results show conclusive evidence of both positive and negative jumps in the Euribor rate using both historical futures and forward looking option prices.