Three Studies in Hedge Funds and Credit Default Swaps

  • Ming-Tsung Lin

Student thesis: Phd


This thesis consists of one hedge fund study and two credit default swap (CDS) studies. The first study investigates the relationship between mega hedge funds (the largest 25% of funds) and two bond yields (U.S. Treasury yield and Baa yield). Using a merged sample of 9,725 hedge funds from 1994 to 2012, I find that hedge fund outflow produced a more significant relationship than inflow, and the dollar outflow of large hedge funds can predict the increase in the bond yields. The association is also more pronounced for large funds with a short notice period prior to redemption. The results suggest that hedge fund flows provide predictive information for the movement of bond yields. The second study investigates the systematic and firm-specific credit and liquidity risks of CDS spreads. Using data on CDS spreads of 356 U.S. firms from 2002 to 2011, I find that systematic credit and liquidity risks are important in cross-sectional prediction of CDS spreads. In addition, the importance of systematic liquidity risk becomes substantial since the financial crisis in 2007. This finding challenges the current Basel III procedures for counterparty credit risk regulations, in which only pure default should be used. In addition, the systematic credit and liquidity factors can be used as a proxy for CDS spreads of firms that do not have traded CDSs. The last study extends Carr and Wu (2010), in which deep out-of-the-money (DOOM) put options and CDSs are associated as they both provide credit insurance for credit protection buyers. Using the Nelson-Siegel (1987) model, I obtain the credit and illiquidity components for DOOMs and CDSs over the period from May 2002 to May 2012. I show that, after controlling the factors that explain the difference between the DOOM and CDS markets, the components converge over time in these two markets. Thus, I can exploit the observed convergence pattern by constructing a simple trading strategy, and this benchmark strategy produces a positive return. I further construct two other strategies based on the component information, and these two refined strategies outperform the benchmark strategy by the Sharpe ratio and Carhart alpha. My three studies contribute to the literature in hedge fund systemic risk and CDS credit and liquidity risks.
Date of Award31 Dec 2015
Original languageEnglish
Awarding Institution
  • The University of Manchester
SupervisorSer-Huang Poon (Supervisor) & Olga Kolokolova (Supervisor)


  • Hedge Fund
  • Hedge Fund Flow
  • Credit Default Swap (CDS)
  • Credit Risk
  • Liquidity Risk

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