An Empirical Study Of Mainland China And United States On The Credit Spreads

This article constructs a financial engineering model using economic fundamentals to evaluate credit spread and quantify the relationship between credit conditions and the economic environment. First, this study uses the Markov Regime Switching Jump-Diffusion model, and is based on the data of Mainland China offered rates spanning from2008-2013to study the credit spread of medium term note and corporate bond. From empirical analysis, we find that the Markov Regime Switching Jump-Diffusion model performs well in the fitness of the term structure of credit spread process. Also, the estimated parameters reflect that there exist characteristics of jump process, moment matching and volatility clustering features in the credit spread of medium term note and corporate bond process. Our empirical study supports that a poor credit rating of medium term note and corporate bond, the credit spread jumped more highly, which shows overweight risk premium of credit risk.And then, we examine the correlations between default intensity processes and the extracted fundamental risk factors based on certain constrains of no arbitrage conditions, and the data of Mainland China and United States offered rates spanning from2001-2013to quantify the impacts of economic determinants on the credit risk. Moreover, this article proposes a reduced form model with economic fundamentals to price credit spread. Instead of selecting specific economic variables, numerous economic and financial variables have been condensed into a few explanatory factors to summarize the noisy economic system.Since the economic environment changes stochastically with the release of new information, in order to summarize the noisy economic system with continuously updated observations we extract three dynamic economic factors from a large number of variables. Although default risks respond differently to distinct economic factors, all parameters are statistically significant.Finally, the financial engineering model based on economic determinants can either facilitate the evaluation of default intensity or manage default risks more effectively by quantifying the relationship between economic environment and credit conditions. This study finds that the economic environment already signaled for the credit crisis at2006and2010.