Dynamic Dependence and Diversification in Corporate Credit

We characterize diversification in corporate credit using a new class of dynamic copula models which can capture dynamic dependence and asymmetry in large samples of firms. We also document important differences between credit spread and equity return dependence dynamics. Modeling a decade of weekly CDS spreads for 215 firms, we find that copula correlations are highly time-varying and persistent, and that they increase significantly in the financial crisis and have remained high since. Perhaps most importantly, tail dependence of CDS spreads increase even more than copula correlations during the crisis and remain high as well. The most important shocks to credit dependence occur in August of 2007 and in August of 2011, but interestingly these dates are not associated with significant changes to median credit spreads.