Calculating credit risk for corporate bonds

[kayy]

Hi All,

Is there a way to quantify the credit risk in a corporate bond ? - We have IRDV01 / duration to measure the interest rate risk but do we have anything similar for credit risk ? If a measure exists how is that calculated ?

Thanks.

 

[JulianT]

The most basic way is to use the credit spread. which is the yield of the bond less the yield of its respective benchmark (in the US these would be your on the run Treasury with the closest maturity). a more precise measure would be to take the spread "over the curve" which would mean interpolating between two benchmark bonds to get the approximate benchmark yield for the same maturity, but be sure to use on the run bonds, which is market convention.

 

[financeguy]

To just build a little bit off what JulianT has said, trading desks look at both DV01 and CS01. DV01 being the risk of the risk-free/benchmark rate moving 1bp, and CS01 being the risk of the credit spread over the benchmark rate moving by 1bp. For a plain old bond these risks should be the same, but for some derivatives they can be different.

 

[kayy]

Thanks Julian T and financeguy for the explaination.
Is the credit spread same as Z-spread (zero vol spread) ? If not what is the difference between them ?
Also to measure the credit spread for sovereign bonds issued by governments like Southafrica, Russia, Netherlands etc.. what will be used as the benchmark curve ?

 

[JulianT]

Thanks financeguy. Never heard the term CS01.
No the credit spread is not the same as the Z-spread. As I mentioned the credit spread is simply the yield of the bond with credit risk less the yield of the benchmark bond. Z-spread is the constant spread that would have to be added to the zero rate of each coupon that would give the current market price, it is mostly used for MBS.
Wit regards to international FI, I'm not 100% sure, since there is also currency risk. Typically sovereigns are the benchmarks. If you want one curve that is THE reference curve, you can't g wrong with the treasury curve. My experience is in Canadian FI and we actively monitor the spread between US and CAN a different tenors, and use treasuries to hedge sometimes. Euro denominated bonds would likely use Bunds as reference curve, though as I say, I never worked with such products, so don't really know.