The scaling behaviour of credit spread returns in an NIG

framework
Author: Hidde Hovenkamp
Academic Supervisor: Svetlana Borovkova (VU)
Professional Supervisor: Sidney Leever (RiskQuest)
February 2, 2015

Abstract
Under Solvency II the internal modeling of yearly VaR provides significant problems caused by the lack
of data at this frequency. As a result, adequate scaling of results estimated on a lower data frequency is
essential for risk management. This paper advocates the use of the normal inverse Gaussian as distribution
to model credit spread risk. Its attractive scaling properties can best be supported by a scaling factor that
accounts for short-run autocorrelations and long memory in the data. For this purpose, scaling factors
based on ARFIMA models as well as Hurst exponent estimation can be used. Empirical analysis on the
scaling of daily to monthly spread return data has proven the superiority of these scaling factors over the
commonly used square-root-of-time. Backtesting monthly VaR with historical losses supports this result.
Scaling factors based on Hurst exponent estimation slightly outperform those using the autocorrelation
function of ARFIMA models.

Student

number: 2451936

Contents
1 Introduction

2 Literature review

2.1

Credit spreads . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2

The normal inverse Gaussian distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2.1

Generalized hyperbolic distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2.2

Re-parametrization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3 Time scaling: theoretical considerations

3.1

Square-root-of-time rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10

3.2

General scaling function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11

3.3

Modeling the underlying process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12

3.3.1

AR(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12

3.3.2

AR(1) plus GARCH(1,1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12

3.3.3

ARFIMA(p,d,q) models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13

3.4

Rescaled range analysis and Hurst exponent estimation . . . . . . . . . . . . . . . . . . . . .

16

3.5

Empirical findings for H . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

19

4 Data

20

4.1

Description of the data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20

4.2

Autocorrelation and volatility clustering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

22

4.3

Fitting the distribution

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

25

Subsamples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

26

Empirical validation of scaling factor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28

4.3.1
4.4

5 Results

29

5.1

ARFIMA(p,d,q) models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

29

5.2

Hurst coefficient estimation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

34

5.3

Scaling the distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

38

6 Backtesting

41

7 Conclusion

44

7.1

Summary of main findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

44

7.2

Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

47

A Simulation results for AR(1) and AR(1) plus GARCH(1,1)

52

A.1 AR(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

52

A.2 AR(1) plus GARCH(1,1)

53

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B Additional figures and tables

58

Introduction

Internal modeling under Solvency II has become increasingly important for the risk management of insurance
companies. Within this framework we distinguish market risk from underwriting risk (life and non-life), credit
risk, operational risk and liquidity risk. For most large insurance corporations, the market risk module is
most important, under which we find equity risk, interest rate risk and credit spread risk. While equity risk
and interest rate risk have been studied extensively, credit spread risk is a relatively new field of investigation.
Within the Solvency framework, credit spread risk and credit risk are two separate modules. Credit risk,
comprised of default- and settlement risk, is the risk of a change in value due to actual credit losses deviating
from expected credit losses due to the failure to meet contractual obligations (Solvency (2007)). Credit risk
can arise on issuers of securities, debtors and intermediaries to whom the company has exposure. Traditional
credit risk models look at probabilities of default, recovery rates and interaction effects between probabilities
of default and exposure for example. Since credit risk concerns securities not traded on the market, a
separate market risk module is associated with securities that contain credit risk but have a market price:
credit spread risk (or spread risk in short). This is defined as the risk of a change in value due to a deviation
of the actual market price of credit risk from the expected price of credit risk (Solvency (2007)). In general,
all fixed-income assets that are sensitive to changes in credit spreads fall under spread risk.
Credit spreads can be decomposed into several components: credit risk premium, illiquity risk premium
and residual premium De Jong and Driessen (2012). The credit risk premium is further divided into a default
risk, which is based on the current credit rating, and a migration risk, which stems from expected losses due
to possible downgrades. The illiqudity risk premium is demanded by investors for not being able to sell large
amounts of an asset, wile the residual spread encompasses other effects (e.g. double taxation in the US).
Credit spread risk can be thought of as the overarching risk associated with changes in credit spread resulting
from any of these underlying factors.
To model movements in credit spreads for risk management purposes, two methods can be distiguished:
bottom-up and top-down. In the former, the distribution of spread shocks is based on analysis of each
component of the credit spread, using similar techniques as in the credit risk module. The top-down method,
on the other hand, determines the distribution of changes in the full credit spread based on time series analysis
of market indices, representative of asset classes held in the portfolio of a company. While the litature on
bottom-up type models is extensive, not much has been written about modeling the credit spread directly
using a top-down approach.
By examining the time varying dynamics as well as distributional properties of credit spreads, spread
risk can effectively be modeled through a top-down approach. A detailled discussion of the modeling of
credit spreads over time will be given in section 2. While the normal distribution has long been suggested
as too simple for the use in risk management, the Students t-distribution was often put forward as the best
alternative for the distribution of most risk factors. More recently, semi-heavy and heavy tailed distributions
as well as extreme value theory have been employed to account for extreme scenarios such as the financial crisis
4

of 2008. The semi-heavy tailed class of normal inverse Gaussian (NIG) distributions has been proposed as
an alternative to the Students t-distribution. This variance-mean mixture of a normal and inverse Gaussian
(IG) distribution has several characteristics attractive for risk management modeling purposes. The main
being that it can be scaled over time. While most studies using the NIG distribution have focused on equity
risk and interest rate risk, the NIG distribution has not often been suggested in relation to the modeling of
credit spread risk.
Besides finding the appropriate distribution for the risk factors, another difficult issue within the Solvency II framework is the time horizon. To determine the Solvency Capital Requirement (SCR), insurance
companies are required to calculate one-year 99.5% (or 1-in-200) Value-at-Risk (VaR). The problem with
yearly VaR is that there is not enough yearly data points to come even close to a proper dataset from which
a distribution can be estimated. While for equity risk, yearly data may be available for as much as 50 years
(which is still very little), such time series of credit spreads do not exist. Consequently, the modeling of risk
factors has to involve scaling from a higher data frequency to obtain yearly estimates. While the squareroot-of-time provides a theoretically simple solution to this issue, the assumptions on which this rule relies
are hardly ever met in practice.
This paper contributes to the gap in the literature on modeling credit spread risk by dealing with the
use of the NIG distribution and examining empirical solutions to the problem of time scaling. It will use
concepts more familiar in the context of equity risk and interest rate risk and see whether these can be
applied for credit spread risk modeling purposes. The paper is structured as follows. Section 2 evaluates the
current literature on credit spreads and the use of normal inverse Gaussian distribution for risk management
purposes. Section 3 discusses the issue of time scaling from a theoretical perspective. Section 4 elaborates on
the data set and methodology used in this research. Section 5 provides a detailed discussion of the results.
In section 6 the results are backtested against historical losses. In section 7 the main findings of this paper
are summarized and suggestions for further research are given.

Literature review

2.1

Credit spreads

Two main theoretical approaches to modeling credit risk can be distinguished in the literature. The structural
approach, first developed in the influential paper by Merton (1974) looks at debt as a contingent claim written
on the assets of the firm. The firm value is modeled through a stochastic process, from which the value of
risky debt is subsequently derived. Another well-known extension of Mertons model is the structural model
proposed by Longstaff and Schwartz (1995). They allow for stochastic interest rates that are described by
the Vasicek model and default occurs when the firms asset value declines to a prespecified level. In case of
default, bondholders recover a constant fraction of the principal and coupon.
However, these models have been criticized because empirical defaults occur too infrequently to be con-

sistent with model predictions (F

uss and Rindler (2011)). Credit spreads implied by structural models have
also been shown to be much lower than those actually observed in the financial markets (Huang and Huang
(2012)). Zhou (1997) provides a solution to this problem by modeling the evolution of the firm through a
jump-diffusion process. He proposes this new structural approach, because the standard diffusion approach
does not capture the basic features of credit risk well. He concludes that by using a jump-diffusion approach,
the size of corporate credit spreads in the market can be matched and various shapes of yield curves can be
generated, including downward-sloping, flat and hump-shaped instead of merely upward-shaped curves for
the standard diffusion approach.
The reduced-form approach directly models the default process of risky debt, by explicitly modeling
its underlying factors such as the risk-free rate and the recovery rate in case of default. It makes use of
stochastic processes similar to those used in the modeling of the riskless term structure to model the default
probability. For example, Jacobs and Li (2008) use a two-factor affine model to describe the joint dynamics
of the instantaneous default probability and the volatility of the default probability. Other papers using this
approach include Jarrow and Turnbull (1995) and Jarrow et al. (1997). Reduced form models may also use a
rating-based approach where default is attained through gradual changes in credit rating driven by a Markov
transition matrix (Della Ratta and Urga (2005)).
Another section of the literature uses an empirical approach by examining the underlying factors which
are able to explain the behavior of credit spreads. These works concentrate on the use of econometric models
and inputs such as interest rates, inflation, taxation, liquidity and implied volatility. Especially the relation
between interest rates and credit spreads has been studied extensively. For example, Longstaff and Schwartz
(1995) find evidence of a strong negative relation between changes in credit spreads and interest rates. Neal
et al. (2000) on the other hand, find little evidence of effects of interest rates on callable bonds. Many more
studies can be included in this list, but the ambiguity of the results indicicate a consensus on the relationship
between interest rates and credit spreads is yet to be found. In addition to the behaviour of credit spreads
itself, the behavior and time-varying dynamics of the volatility of credit spreads is studied, using GARCH-like
models (e.g. see Pedrosa and Roll (1998)). Alizadeh and Gabrielsen (2013) extend such techniques to examine
the dynamic behavior of higher moments of credit spreads such as skewness and kurtosis. They, together

with Heston and Nandi (2000)Tahani and Ecole

des hautes etudes commerciales (Montreal(2000), claim
incorporating higher moments in the modeling of credit spreads can greatly improve results for pricing and
risk management purposes. By using a Threshold GARCH (TGARCH) model, or GJR-GARCH, Alizadeh
and Gabrielsen (2013) create an assymetric response of volatility to positive and negative shocks. The idea
is that large negative squared returns have a stronger effect on volatility than positive ones.
The traditional literature on credit spread modeling focuses on stationarity versus non-stationarity of
credit spreads. For example, Kiesel et al. (2001) suggest that credit spreads are driven by a combination of a
stationary and random walk component and claim spread risk is in fact the most important risk component
of high quality portfolios. However, Della Ratta and Urga (2005) argue we should also look at the degree

of dependence. They investigate whether credit spreads are short- or long-term memory processes using
a fractional Brownian motion framework. The degree of dependence of credit spreads is relevant because
it strongly influences the scaling behavior. Batten et al. (2002) investigate the long-term dependence and
scaling behavior of Australian Eurobonds credit spreads and find a negative long-term dependence. This
implies that positive spread returns will follow negative spread returns, and negative follow positive. As a
consequence, the square root of time rule for scaling volatility is inappropriate, which will be explained in
detail later in this paper.
Reviewing the various types of models and methods used to examine credit spreads is useful for this paper
in two ways. First, to properly understand any distributional properties of credit spreads as well as scaling
behaviour of volatility or higher moments one must be familiar with the data generating process of such
credit spreads. Second, by modeling credit spreads appropriately simulation techniques can be employed to
compute empirical scaling factors. Before we move to elaborate on these and other techniques for calculating
scaling factors, let us first discuss the hypothesized distribution of credit spread returns: the normal inverse
Gaussian (NIG).

2.2

The normal inverse Gaussian distribution

The normal inverse Gaussian (NIG) distribution is defined as the variance-mean mixture of a normal distribution with the inverse Gaussian (IG) as the mixing distribution. This class of continuous distributions was first
introduced by Barndorff-Nielsen (1977) and has become increasingly popular in finance, particularly for risk
management purposes. Further relevant references of the NIG distribution from a risk analysis perspective
include Barndorff-Nielsen (1997), Barndorff-Nielsen and Prause (2001) and Venter and de Jongh (2002).
The NIG distribution is able to model both symmetric and assymetric distributions, with long tails in
both directions using only four parameters. The tail behavior has been classified as semi-heavy tailed, so it
may not be able to deal with fully heavy tails but generally fits well to financial data. Moreover, another
very attractive property is that the sums of NIG distributed random variables with the same parameters are
again NIG distributed. In other words, it is closed under convolution. This property proves very useful in
the time scaling of risk and is not met by many other distributions, such as the commonly used Students
t-distribution Spadafora et al. (2014). Spadafora et al. (2014) show that only when lies below the critical
value ( = 3.14) is it possible to scale the Students t-distribution.
The NIG distribution can be parametrized in many ways, but the most common specification is the one
with (, , , ) parameters. This parametrization will be referred to as standard throughout this paper. The
parameter space is given by
0 || , < , > 0
The distribution is symmetric around if = 0. In the standard parametrization, the sum of two NIG
distributed variables is NIG distributed with (, , , ) = (, , 1 + 2 , 1 + 2 ). The NIG distribution has

the following density

fN IG (x; , , , ) = e

2 2

+ (x

)2

K1 (

p
2 + (x )2 )e(x)

where K1 is the modified Bessel function of third order and index 1. In general, we denote the integral
notation of the modified Bessel function of third order as
K (x) =

1
2

t1 e 2 x(t+t

dt,

x>0

The moment generating function of N IG(, , , ) is given by

2 2 2
2
M (u; , , , ) = e[ ( ) ( (+u) )]+u
All moments of the distribution thus have explicit expressions. In particular, the mean, variance, skewness
and excess kurtosis are
1 = +

2
3
3
3 =
( )
3(1 + 4 2 /2 )
4 =
()
2 =

where =

p
(2 2 ). For some purposes, instead of the classical skewness and kurtosis values, it is useful

to work with steepness and asymmetry parameters and defined by

= (1 + )1/2 ,

The domain of variation for (,) is the NIG shape triangle

0 < < 1, 1 < < 1,
Distributions with = 0 are symmetric and the normal and Cauchy distributions can be found for (,)
near (0, 0) and (0, 1). Barndorff-Nielsen and Prause conclude that in practice values of for daily financial
return series lie between 0.6 and 0.9 Barndorff-Nielsen and Prause (2001). This deviation from zero strongly
indicates non-normality.

2.2.1

Generalized hyperbolic distribution

To better understand the characteristics of the NIG distribution it is useful to see its relation with other
distributions within the more general class of generalized hyperbolic (GH) distributions. The GH distribution
is obtain by mixing normal with a generalized inverse Gaussian (GIG) as the mixing distribution and is a five
parameter class of distributions with (, , , , ) as standard parametrization. We will not go into much
detail on the exact density and characteristics of the GH class of distributions, but figure 11 in the appendix
shows how to obtain the NIG distributions as well as its relation to other well-known distributions. Using
the standard parametrization, the NIG distribution is defined as a GH distribution with fixed parameter
= 12 . From the figure it also evident that the normal and Cauchy distributions are indeed special cases
of the NIG distribution.
2.2.2

Re-parametrization

As mentioned earlier, several parametrizations are used in the literature. In this paper we will generally
use the standard (, , , , ), but one other is relevant to discuss briefly. It has been shown by Breymann
and L
uthi (2013) that switching to parameters (,
, , , ) can be very useful for optimization purposes. It
becomes much easier and faster to fit the distribution to empirical data, because this parametrization does
not necessitate additional constraints to eliminate the redundant degree of freedom (Breymann and L
uthi
(2013)). Therefore, it is relevant to elaborate on how to switch from parameters (,
, , , ) to the standard
(, , , , ).
In the NIG case, when = 12 , then
= = . From there, we can obtain the standard parameters
using the following mapping:
r
=

1
( + ( )2 )
2

2
p
= 2

while stays the same. From the closure under convolution property of the NIG distribution we know that
the sum of S NIG distributed random variables are distributed as N IG(, , S, S) assuming the same and
parameters. For the alternative parametrization this translates into the sum of S NIG distributed variables

being distributed as N IG(S

, S, S, S). This will prove very useful for re-scaling the distribution to a
lower data frequency.

Time scaling: theoretical considerations

In risk management, a lack of data is often a problem for determining the distribution of risk factors.
Especially within the Solvency II framework, where insurance companies have to compute the one-year
9

99.5% Value at Risk (VaR), data frequency becomes an issue. There is not nearly enough yearly data to
compute such a VaR, since this would mean at least 200 data points have to be available. To overcome this
problem, various solutions have been proposed. Most common are: the use of overlapping data and scaling
results from higher frequency data.
The use of overlapping data is generally seen as an invalid method as it greatly increases the autocorrelation in the data and makes the results very difficult to interpret (Harri and Brorsen (1998)). The second
option is to make use of higher frequency data. For example monthly data can used to then scale the results
for yearly VaR. Although this sounds relatively simple, in practice it turns out to be rather complicated. In
the next section, various methods for scaling the data will be discussed in detail. We will start with the most
commonly used square-root-of-time rule and explain why this is fact inappropriate in most cases.

3.1

Square-root-of-time rule

A common rule of thumb in risk management, borrowed from the time scaling of volatility, is the squareroot-of-time rule (SRTR) according to which financial risk is scaled by the length of the time interval. This

is similar to the Black-Scholes option pricing formula where a t-period volatility is given by t. Let us first
briefly explain where the SRTR comes from, before elaborating on the assumptions it is based on and why
it most often does not hold in practice.
If we use the example of the sum of k daily returns, where one return is denoted as Xi , the variance over
this horizon k is defined as
k
k
k
k
k X
X
X
X
X
i j ij
2 (k) = V ar(
Xi ) = Cov(
Xi ,
Xj ) =
i=1

i=1

j=1

i=1 j=1

To go from this expression to the SRTR we have to make two assumptions. First, by assuming X is serially
uncorrelated, the sum of all ij will equal k. In other words, ij = 1 for all i 6= j. Second, under the
assumption of stationary variance, i.e. V ar(Xk ) = 2 for all k, the expression above simplifies to
v
u k k

uX X

(k) = t
i j ij = 2 k = k
i=1 j=1

where is the constant one-day volatility and k 1. Hence the time scaling factor under the SRTR is
defined as

S(k) =

(1)

McNeil et al. (2005) provide a more detailled explanation of these concepts and the consequences for value
at risk (VaR) and expected shortfall (ES).
While the SRTR is often used in practice and even advocated by regulators, it leans heavily on the

10

assumption of independent and identically (i.i.d.) distributed returns as well as normality of returns (Wang
et al. (2011)). These assumptions are not met in empirical financial returns and numerous stylized facts are
in conflict with these properties. Various studies have attempted to identify how these different effects bias
the approximation of the SRTR.
First, dependence in asset returns is often present, both in levels and higher moments. As Wang et al.
(2011) illustrate, the SRTR tends to understate the scaling factor and hence the tail-risk when returns follow
a persistent pattern (i.e. momentum is present), while it overstates this risk for returns with mean-reverting
behavior. In similar fashion, volatility clustering is found present in returns of most financial assets. Under
the dynamic setup introduced by Engle (1982) and Bollerslev (1986) it has been demonstrated that the
k-day estimate scaled by the SRTR yield overestimates of the variability of long-horizon volatility. Diebold
et al. (1997) show, using the GARCH(1,1) volatility process, that while temporal aggregation should reduce
volatility fluctuations, scaling by the SRTR amplifies them.
In addition to serial correlation and volatility clustering effects, non-normality of financial returns also
affects scaling with the SRTR. Although allowing for dynamic dependence in the conditional variance partially
contributes to the leptokurtic nature of the distribution, as Wang et al. (2011) mention, these GARCH effects
alone are not enough to explain the excess kurtosis often present in return series. On the one hand this has led
to studies using Students t- or other heavy tailed distributions in their empirical GARCH modeling. On the
other hand, researchers have turned to models that generate disregularities. Merton (1976) first introduced
a jump diffusion model that created discontinuous paths. Yet it was only until the work of Danielsson and
Zigrand (2006) that it became evident how underlying jumps influence the SRTR approximation of longer
horizon tails risks. They showed that the SRTR underestimates the time-aggregrated VaR and this downward
bias increases with the time horizon, caused by the existence of negative jumps. Wang et al. (2011) corectly
question whether this downward-bias would switch direction or just become negligible if the jump process
was not confied to negative price jumps only.
Although it is clear that various underlying effects influence the SRTR and give rise to biases in its
scaling, it is unclear what the overal effect of these influencing factors combined is. It could well be that a
negative bias coming from jumps is offset by a positive bias resulting from momentum in the return series.
Nevertheless, it is clearly the case that the square-root-of-time rule should be used with caution at best.
Therefore, let us now turn to a variety of alternatives for determining the appropriate scaling factor in case
of failure to meet some of the underlying assumptions on which the validity of the SRTR is based.

3.2

General scaling function

Let us start with a more general formula of the scaling of volatility, where the assumption of ij = 1 for all
i 6= j is dropped. Rab and Warnung (2010) show that instead of the square-root-of-time rule an alternative
scaling factor for the volatlity can be constructed. This scaling factor corrects for all relevant autocorrelations,

11

making use of the autocorrelation function (acf). This scaling factor is defined as
v
u
k1
u
X
S(k) = tk +
2(k i)(i)

(2)

i=1

where S is a funtion of k, which is the length of the scaling window and (i) the acf at time i. It is immediately
evident that the SRTR is a special case, where (i) = 0 for all i. Then equation 2 reduces to equation 1.

3.3

Modeling the underlying process

To compute a scaling factor that accounts for autocorrelation in the data, we need the acf for our spread
return data. This means that we have to make certain assumptions about the data generating process that
drive these spread returns. We can specify a model to approximate this process, from which we can extract
the acf and compute S(k) using equation 2.
To use this approach, we have to chose a model specification that accurately describes our daily spread
return data. In the next subsections, we will elaborate on three type of model specifications which we will
investigate further. First, when we only want to account for the autocorrelation in the data we can use a
simple AR(1) model fitted to the spread return data. Second, when also accounting for volatility clustering
an AR(1) plus GARCH(1,1) model can be used. Third, we investigate a class of fractal processes to describe
our spread return data. These models are called ARFIMA(p,d,q) models.
3.3.1

AR(1)

When we only have to deal with autocorrelation, we can use an auto-regressive process or order 1 (AR(1)),
which looks as follows
xt+1 = xt + t+1
with || < 1 for a stationary process x. When there is no volatility clustering, then the innovations 
N (0, 2 ). Since the autocorrelation function of an AR(1) process is given by (i) = i , the scaling factor S(k)
becomes
v
u
k1
u
X
S(k) = tk +
2(k i)i
i=1

3.3.2

AR(1) plus GARCH(1,1)

When we include volatility clustering in the model, we use a GARCH(1,1) process to model the variance
2
t+1
= + 1 2t + 1 t2

12

(3)

The theoretical scaling factor for the AR(1) plus GARCH(1,1) model does not change, as the GARCH process
does not influence the autocorrelation function. However, it is interesting to use Monte Carlo simulation
techniques to compare the results with the theoretical scaling factor. This can be done by simulating daily
observations, generating monthly observations from these (using k = 22) and the comparing the sample
variance for the two. The simulated scaling factor then becomes
v
u 2
u m (k)

S(k)
=t
.
d2
3.3.3

(4)

ARFIMA(p,d,q) models

A theoretically more sound way of modeling credit spreads is the class of so-called fractal processes, shown by
for example Della Ratta and Urga (2005). Let us start with the simplest one. The fractional Brownian motion
(fBm) BH (t) is a Gaussian process with zero mean, stationary increments, variance E[BH (t)BH (t)] = t2H
and covariance E[BH (t)BH (s)] = 12 (t2H + s2H |t s|2H ).
Depending on the value for the parameter H, the fBm has independent increments (H =

1
2 ),

positive

covariance between two increments over non-overlapping time intervals ( 12 < H 1) or negative covariance
between increments (0 < H < 12 ). In the case of

1
2

< H < 1 we say the process has long memory.

It is worth noting that the fBm is part of a more general class of processes, called self-similar processes.
A centered stochastic process Xt is said to be statistically self-similar with Hurst coefficient H, if it has the
same distribution as aH Xat , for all a. The autocorrelation function of a self-similar process, and hence of
the fBm, is given by
(j) =

1
[(j + 1)2H 2j 2H + (j 1)2H ]
2

The simplest long memory model is fractional white noise, which is defined as
yt = (1 L)d t
where L is the lag operator. E(t ) = 0, E(2t ) = t2 , E(t s ) = 0 for s 6= t and d = H

1
2

is the fractional

difference parameter. Let yt I(d). For d = 0, Yt = t and process is serially uncorrelated, while if d > 0
the process has long memory and is mean square summable. Yt is stationary for all d <
d>

1
2

and invertible for

21 .

A more general class of processes that contains fractional white noise as a particular case is the Autoregressive Fractionally Integrated Moving Average (ARFIMA) model first introduced by Granger and Joyeux
(1980). The ARFIMA(p,d,q) process is defined as
(L)(1 L)d (yt ) = (L)t

13

where (L) and (L) involve autoregressive and moving average coefficients of order p and q respectively and
t is a white noise process. The roots of (L) and (L) lie outside the unit circle. A fractional white noise
process, or fractional Brownian motion, is essentially equivalent to an ARFIMA(0,d,0) process. ARFIMA
processes are covariance stationary for 21 < d <
d = 0. For d

1
2,

1
2,

mean reverting for d < 1 and weakly correlated for

these process have infinite variance, but it is more common in the literature to impose

initial value conditions such that yt has changing, but finite, variance.
While the autocorrelation function of the ARFIMA(0,d,0) or fBm was a relatively simple formula, the
acf for an ARFIMA(p,d,q) is much more complex. Deriving the acf is beyond the scope of this paper, so we
will use the results as shown in the book on long memory by Palma (2007). He uses the following relation
between the auto-covariance function and the autocorrelation function
(h) =

(h)
(0)

and deduces that

(h) =

q X
p
X

(i) j C(d, p + i h, j )

i=q j=1

with
"
i = j

p
Y

#1
(1 i j )

i=1

(j m )

m6=j

and
C(d, h, ) =

0 (h) 2p
[ (h) + (h) 1]
2

where (h) = F (d + h, 1, 1 d + h, ) and F (a, b, c, x) is the Gaussian hypergeometric function (see Palma
(2007)). Though seemingly complex, the use of this autocorrelation function will prove very useful later in
this paper, when we want to compute scaling factors based on an ARFIMA process. We will again make us
of the theoretical scaling formula from equation 2 and plug in the acf as described above.
Let us now elaborate on methods for estimating the value of d. We distinguish two parametric methods:
the Whittle estimator and the exact maximum likelihood (EML) estimator proposed by Sowell (1992). As
Della Ratta and Urga (2005) rightly note, both these procedures are applicable to stationary ARFIMA
models, yet many financial time series lie on the border of being non-stationary. However, since we are
interested in the spread return series - the first difference of the original spread series - this problem will most
likely be less of an issue in our case.
The parametric procedure, first proposed by Whittle (1953), leads to an estimation of d which we will

14

denote as dW . The estimator is based on the periodogram and involves the following function
Z

Q() =

I()
d
fX (, )

where fX (, ) is the known spectral density at frequency , I() the periodogram function and denotes
the vector of unknown parameters, including d as well as the AR and MA coefficients. The Whittle estimator
is the value of that minimizes the function Q(). Reisen et al. (2001) show that dW is strongly consistent,
assymptotically normally distributed and assymptotically efficient.
Sowell (1992) derived the exact maximum likelihood estimator for ARFIMA processes with normally
distributed innovations. However, this approach is computationally demanding because with each iteration
of the likelihood a T-dimensional covariance matrix has to be inverted, where each element is a nonlinear
fucntion of hypergeometric functions. It also requires all roots of the autoregressive polynomial to be distinct
and for the theoretical mean parameters to either be zero or known. The EML estimates of d, herafter
denoted as dE , are assymptotically normally distributed, making it possible to test hypotheses on d.
To get a better understanding of ARFIMA processes, figure 1 shows 1000 simulated observation for three
different ARFIMA specifications. The first is a pure fractional Brownian motion with d = 0.4. The second is
an ARFIMA(1,d,1) process with d = 0.4 and positive autoregressive and moving average parameters, which
shows momentum behaviour. The third model is an ARFIMA(1,d,1) process with d = 0.4 and negative
autoregressive and moving average parameters, which shows mean reverting behaviour.

Figure 1: 1000 simulated observations from ARFIMA models with Gaussian white noise N(0,1). The first series is
an ARFIMA(0,d,0) model with d = 0.4. The second series is an ARFIMA(1,d,1) model with d = 0.4, 1 = 0.6 and
1 = 0.3. The third series is an ARFIMA(1,d,1) model with d = 0.4, 1 = 0.6 and 1 = 0.3.

A more direct approach to calculating the scaling factor assumes an fBM as the data generating process for

15

credit spreads and uses some of the properties without actually estimating the parameters. From equation 2
we know that the theoretical scaling rule is given by
v
u
k1
u
X
S(k) = tk +
2(k i)(i)
i=1

where (i) is the autocorrelation function. Plugging in the autocorrelation function of the fBM we get
v
u
k1
u
X


S(k) = tk +
(k i) (i + 1)2H 2i2H + (i 1)2H

(5)

i=1

with k the lenghth of the scaling horizon, as before. Now all that remains is to estimate the Hurst exponent
H. This can be done directly from estimating the ARFIMA(0,d,0) process on the data and using the relation
= d + 0.5. Another group of methods uses different techniques to estimate H directly from the data. We
H
will elaborate on these methods in the next section.

3.4

Rescaled range analysis and Hurst exponent estimation

Rescaled range analysis was first introduced by Hurst (1951) while studying the statistical properties of the
Nile. He expressed the absolute displacement in terms of rescaled cumulative deviations from the mean and
defined time as the number of data points used. The classical rescaled range statistic is defined as

Qn =

k
k
X
X

1 
max
(Xj Xn ) min
(Xj Xn )
n
j=1
j=1

(6)

where n is the usual (ML) standard deviation estimator. The first term is the maximum of the partial sums
of the first k deviations of Xj from the mean and is always nonnegative. The second term is the minimum over
this same sequence and is always nonpositive. The difference, the range, is therefore always nonnegative:
Q 0. We refer to the rescaled range statistisc as Qn , but it is also commonly known as (R/S). To avoid
confusion with the scaling factor S we will use the term Qn .
The scaling exponent of Qn = c nH is now referred to as the Hurst exponent and gives us information
on the presence of long-range correlations in time series. If the data is completely independent H will be
1
2.

By computing the values of the rescaled range Qn for different values of n, we can estimate the Hurst

exponent Couillard and Davison (2005). This is done through a simple ordinary least squares regression:
log(Qn ) log(c) + H log(n). Barunik and Kristoufek (2010) show that Qn is biased in small samples.
Couillard and Davison (2005) Mandelbrot and Wallis (1968) and Mandelbrot and Taqqu (1979) demonstrate
the superiority of rescaled range analysis to more convential methods of determining long-range dependence
such as the anaysis of autocorrelations or variance ratios. Monte Carlo simulation studies show that the
Qn statistic can still detect long-range dependence in highly non-Gaussian time series with large skewness

16

and kurtosis (Mandelbrot and Wallis (1968)). This property is especially useful for our purposes, since
we are hypothesizing credit spread returns to be NIG distributed which deviates strongly from the normal
distribution.
One problem with rescaled range analysis is the stationarity assumption as explained in Couillard and
Davison (2005). The test statistic assumes that the underlying process remains the same throughout the
process. To test the validity of this assumption and the effect on the estimation of H, Couillard and Davison
(2005) propose to divide the data set in both overlapping and non-overlapping subperiods. The Hurst
exponents of the subsamples can then be compared to the exponent of the entire sample to see if it is
constant through time. In this sense there is a trade-off between the amount of data needed to properly
estimate H and the stationarity assumption.
Another major shortcoming of rescaled range analysis is the sensitivity to short-range correlations (Couillard and Davison (2005)). Although the ratio of

log Qn
log n

converges to

1
2

in the limit, this fraction will deviate

from this value in the short run (Lo (1989)). One way to account for this bias is to use a the modified Qn
statistic introduced by Lo (1989). Lo proposes to use the following modification:

Qn =

k
k
X
X

1 
max
(Xj Xn ) min
(Xj Xn )
n (q)
j=1
j=1

(7)

where the only difference with the traditional Qn lies in the denominator:
v
u
q
X
u
x2 + 2
j (q)j ,
n (q) = t
j=1

j (q) = 1

1
,
q+1

q<n

where
x2 and j are the usual sample variance and autocovariance estimators of X. If X is subject to
short range dependence, the variance of the partial sum is not simply the sum of the variances of the
individual terms, but also includes autocovariances (Lo (1989)). Therefore, the esimator n (q) also includes
the weighted autocovariances up to lag q, where the weights ensure a positive n 2 (q). Determining the
appropriate truncation lag q must de done with some consideration of the data. Teverovsky et al. (1999)
made a thorough investigation of the modified Qn statistic and found that as the lag q increased the statistic
had a strong bias towards accepting the null hypothesis of no long-range correlations. In this paper use a
data-driven optimal value of q 1 .
In a paper published a few years after Lo (1989), Moody et al. (1996) claim that Los modified rescaled
range statistic Qn is itself biased and introduces other problems, causing distortion of the Hurst exponents.
They propose another variation of the statistic that corrects for mean bias in the range R, but does not suffer
from the short term biases that Los modification introduces. Experiments on simulated random walk, AR(1)
and high-frequency exchange rate data support their claims Moody et al. (1996). Moody and Wu argue for
1q


= ( 3N
2

1
3

( 1
)3

Teverovsky et al. (1999)

17

replacing the biased rescaling factor of Lo by an unbiased estimate of the variance, resulting in
Qn =

k
k
X
X

1 
max
(Xj Xn ) min
(Xj Xn )
n (q)
j=1
j=1

(8)

with
v
u
q
q
tX
tX
0 +N
0 +N
X
u
2 X
N j 1
2+

(X

X
)
j (q)

(q)
(Xt Xn )(Xtj Xn )
n (q) = t 1 + 2
t
n
j
N 2 N 1 t=t +1
N j=1
t=t +1
j=1
0

where j (q) is the same weighting function as defined by Lo. Xt and Xn are the return process X at time t
and the mean of X respectively (like before).
In addition to these modifications, Annis and Lloyd (1976) developed a modified version of the Qn statistic
that corrects the small smaple bias of the original statistic. Peters (1994) later denoted that the Anis and
LLoyds corrected version is again more difficult to implement for large n, as the correction includes a gamma
function, which becomes computationally intensive. An approximating version, which circumvents the use
of the gamma function, is proposed by Peters, to be used in case of samples larger than approximately 300.
The adjustments in both these version cause the standard deviation to scale at a slower rate than the range
for small values of n. Hence, the rescaled range will scale at a faster rate (H will be greater than 0.5) when
n is small. As such, we can define the Anis-LLoyd-Peters corrected expected Qn statistic as

E(Qn ) =

(n 12 )

Pn1 q (nr)
r=1

n 12

(9)

where n is the length of the subperiods. We have set this to 50 following Peters (1994).
So now we have elaborated on types of rescaled range analysis, which can yields us Hursts original Qn ,
Los modified Qn , Moody and Wus slightly differently modified Qn and finally Anis-Lloyd-Peters expected
statistic E(Qn ). From these statistics we can compute an estimated value for the Hurst exponent H, as has
been explained before. However, there is another method for estimating H, which is called the generalized
Hurst exponent (GHE) approach.
This method was recently re-explored for analysis of financial time series by Di Matteo et al. (2003) and
is based on scaling of the q-th order moment of the increments of the process X(t). The statistic is defined
as
PT
Kq ( ) =

t=0

|X(t + ) X(t)|q
(T + 1)

(10)

for time series of length T. The statistic scales as Kq ( ) c qH(q) . Barunik and Kristoufek explain that the
case of q = 2 is especially relevant for the purpose of long-range dependence detection, as K2 ( ) is connected
to the scaling of the autocorrelation function of the increments Barunik and Kristoufek (2010). Therefore,

18

we can estimate H(2) using this approach, which will be comparable to estimates of H using rescaled range
analysis. The case of H(2) is extremely relevant for the purposes of this paper as it is directly related to
the scaling of increments of a process over time. As such the scaling of credit spread changes from a daily
to a monthly range will surely benefit from the results of the GHE approach. For q=1, H(1) characterizes
the absolute deviations of the process Di Matteo et al. (2003). Following Di Matteo et al. (2003)Di Matteo
(2007) we choose = 19.
Barunik and Kristoufek (2010) have conducted an elaborate comparitive study between various approaches
of computing the Hurst exponent as have been explained in the last sections. They conclude that rescaled
range analysis together with generalized Hurst exponent (GHE) approach are most robust to heavy tails in
the underlying process. Di Matteo (2007) claims in his paper that the GHE method is in fact more robust
to outliers than the rescaled range analysis approach. This paper will further investigate these results by
comparing the estimated Hurst exponents in its performance for time scaling credit spread returns. These
H , H
Lo , H
MW , H
ALP and H
GHE .
five Hurst exponents estimates will be denoted as: H

3.5

Empirical findings for H

Before we move to our empirical analysis it is important to review empirical results in the literature for
Hurst exponent estimation. This helps understand and interpret the results and provides a framework for
comparison.
Many papers in the literature have studied financial time series through rescaled range analysis or other
methods of estimating the Hurst exponent. Most studies have focused on the scaling of stock returns so
we will briefly discuss these findings first. Domino (2011) finds values between 0.4 and 0.8 for the Warsaw
Stock Exchange. For the major Middle East and North African (MENA) stock markets Rejichi and Aloui
(2012) find values of H > 0.5 indicating long range dependence on all MENA markets investigated. Morales
et al. (2012) look at a dynamically calculated Hurst exponent for U.S. companies on the NYSE hit by the
financial crisis. They also find values around 0.5. In general, most papers find values for H of 21 and up when
examining time series of stocks.
Now let us turn to the empirical findings of scaling behaviour of credit spreads. Although much less
has been written about credit spreads than stock returns a few studies are worth mentioning. McCarthy
et al. (2009) find strong evidence of long memory in yield spreads with H ranging between 0.85 and 1. They
look at the spread between AAA and BBB corporate bonds as well as between either and 10-year Treasury
bills. McCarthy et al made use of daily, weekly and monthly data, using two techniques: wavelet theory and
an approach building on the aggregated series as proposed byTaqqu and Teverovsky (1998). For the latter
approach, they find that the strongest evidence of long memory is for the weekly spread between AAA and
BBB, while the lowest estimate for H is found on the spread between BBB and 10-year Treasury bills. Based
on the wavelet method, the results indicate the strongest long memory for the monthly AAA to BBB spread
while the lowest coefficient is again the weekly spread between BBB and 10-year Treasury bills.

19

Batten et al. (2002) examined the volatility scaling of Australian Eurobond spreads by calculating the
scaling factor H based on implied volatilities for several multi-day horizons. Their data included the spread
between AAA Eurobonds and AA Eurobonds with different maturities (2,5,7 and 10 years) as well as the
spread between AA Eurobonds and A Eurobonds with different maturities. For all spread return series tested,
values of H lower than 12 were estimated, indicating negative long-term dependence. In general, the estimated
scaling exponent increased for spreads with lower ratings. Batten et al. looked a scaling horizons of 5, 12,
22 and 252 days and found evidence that the Hurst exponent decreased when estimated on a longer time
horizon.

Data

4.1

Description of the data

To investigate the scaling behaviour and distributional properties of credit spread changes various time series
will be examined. This paper will focus on European corporate bond spread indices, where the spread is
defined as the option-adjusted spread (OAS) over the German government bond. All time series have been
obtained from Barclays Live. The series for the OAS over the german government bond runs from 18-05-2000
until 30-04-2014. Any empty data points have been removed from the series as these are associated with
days when the stock markets where closed and hence are irrelevant. The average trading days per year in
the data set was found to be 260 which we used to come to a monthly average of

260
12

= 21.67 (which will be

rounded to 22).
We have chosen to examine corporate bond indices instead of individual bonds for several reasons. First,
each index incoporats numerous bonds a certain market segment, so the obtained results can be considered as
a more widespread pehonomenon (Martin et al. (2003);Della Ratta and Urga (2005)). If only a small number
of bonds would exhibit such behaviour it would probably not be noticable. A second, more practical reason is
that testing for long-range dependence and distribution fitting requires large samples, which are more readily
available for indices than for single bonds (Martin et al. (2003)). Third, the market for individual corporate
bonds is often illiquid and the consistency of the credit spread component of corporate yield is strongly
affected by liquidity constraints, so using indices overcomes this issue (Della Ratta and Urga (2005)).
All indices are part of the greater Barclays Euro-Aggregrate index which consists of bonds issued in the
euro and must be investment grade rated, fixed-rate securities with at least one year remaining to maturity
2

. The mininimum outstanding amount for all bonds in the index is 300 million euro. All indices are

reviewed and rebalanced once a month, on the last calendar day of the month. The spread incidices have
been categorized on the basis of three characteristics: sector, rating and maturity. Three coporate sectors
are distinguished: financials, industrials and utility. In addition, the total corporate sector is considered. For
ratings we have only looked at investment grade and higher, which means we distinguish: AAA, AA, A and
2 Index

description Barclays Live

20

BBB. The ratings are determined by looking at the three main rating agencies (Moodys, Standard & Poors
and Fitch). At least two out of three ratings must be availabe and the lowest rating is taken. For maturity
the following indices are examined: 1 to 3 years, 3 to 5 years, 5 to 7 years, 7 to 10 years and 10 years and
more.
Table 1 shows summary statistics for all the bond indices used. The first columns of the table show
characteristics of the index and credit spread series (OAS) while the last four columns provides descriptives
of the associated credit spread returns (dOAS). The corporate sector index includes the largest number of
issuers, followed by 10+ years maturity and AAA rated. The biggest average spread is for 10+ years maturity,
followed by industrials and 7-10 years maturity. The table also gives the starting values (at 8-05-2000) and
end values (30-04-2014) of the spread series. If we look at the spread returns, it can be seen that the mean is
practically zero for all indices. In additon, the standard deviations of the returns are relatively comparable
between indices, except for two cases. First, it is worth noting that the 3-5years maturity series shows to be
less volatile than for example 1-3years while this would not be expected. Second, the 10+ years maturity
index has by far the largest standard deviation of all the series, as well as very small and large minimum
and maximum, indicating large volatility. Between the indices categorized by sector, the financials seem to
be most volatile with a significantly larger standard deviation and large minimum and maximum values (in
aboslute terms).

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Issuers
1466
623
149
694
939
796
679
583
303
727
622
900
1051

OAS (in basis pts)

Mean Start End
0.692 1.015 1.362
0.581 1.111 1.496
0.771 1.035 1.085
0.940 0.903 1.247
0.155 0.443 0.581
0.269 0.631 0.680
0.274 0.734 0.723
0.330 0.780 0.709
0.270 0.812 0.573
0.150 0.178 0.248
0.308 0.367 0.614
0.826 0.848 1.265
1.372 1.292 2.159

Mean
0.009
0.015
0.008
-0.001
0.008
0.010
0.013
0.013
0.016
0.001
0.002
0.001
-0.002

dOAS (in basis pts)

Std. Dev.
Min.
2.566
-33.655
3.700
-78.527
2.328
-29.379
2.261
-26.237
2.501
-41.897
2.428
-36.849
2.411
-31.608
2.488
-34.576
2.347
-23.294
1.461
-15.304
3.520
-53.381
3.846
-86.517
6.401
-172.930

Max.
23.195
65.081
26.261
22.683
25.508
21.817
20.810
19.737
21.566
20.764
40.776
37.672
59.265

Table 1: Descriptive statistics for daily credit spread series and daily credit spread return series. OAS is optionadjusted-spread and dOAS is the return of option-adjusted-spread (absolute change)
The risk factor for credit spread risk can be modeled in three ways: absolute changes, relative changes or
log-changes. The log-change model is immediately ruled out because it is theoretically possible for spreads
to become negative, as they are measured against the german government bond yield or LIBOR curve. Some
corporate bond yields can temporarily be lower than this yield resulting in a negative spread. Although this
does not happen often there are a few cases present in our times series. The difference between the relative
change model and absolute change model is that in a relative change model the spreads shock will be higher

21

when spreads are high, while in an absolute change model the shocks are independent of the current spread
level. The latter makes capital requirements less cyclical and also avoids any problems that might occur
when spreads are almost zero. Therefore we will evaluate absolute changes in credit spreads. For simplicity
sake, these will henceforth be referred to as spread returns.
Figure 2 shows the time series plots of spread returns for the four different sectors. As can be seen from
the figure, there are clearly very volatile periods and much more quiet periods. Especially the financial crisis
in 2008 is very visible (starts around trading day 2000 in the sample) and volatility remains high until quite
recently. The differences in behavior between the indices of the four different sectors is limited.

Figure 2: Time series of credit spread returns (absolute changes) between May 2000 and April 2014 (in basis points).
First panel: EU Corporate (Corp.) Second panel: EU Financials (Fin.) Third panel: EU Utility (Uti.) Fourth panel:
EU Industrials (Indu.)

4.2

Autocorrelation and volatility clustering

To understand the scaling behaviour of credit spread returns two of the most important characteristics of
time series to examine are: autocorrelation and volatility clustering. Both of these concepts play a very
important role and shall now be elaborated upon.
22

Let us start with a plot of the sample autocorrelation function (acf) of the spread return series to get a
better understanding for the data. Figure 3 shows these plots for the return series categrorized by sector,
with up to 22 lags (one month). From the figure it can be seen that the all corporate index has strong
positive autocorrelation with values beteen 0.1 and 0.2 for the first 10 lags. This indicates momentum in the
spread return series and suggest some kind of autoregressive process might drive the returns. The utilities
and financials sectors also indicate quite strong positive autocorrelation, although the values ares slightly
lower. The industrials sector has the least autocorrelation, but still gives slightly positive values. For the
other nine spread return series, the sample acf plots can be found in figures 12 and 13 in the appendix.
To compare the relative size for all spread seris figure 4 shows a heatmap of the sample autocorrelation
coefficients. Table 19 in the appendix shows the corresponding values of these sample autocorrelation coefficients in a t able. We can see that the indices categrorized by sector have relatively high positive coefficients
while those categrorized by rating or maturity are generally lower or even negative. For all spread series
holds that as the lags increase the coefficients go down which is as expected. Interesting to note is that in the
heatmap we can see that lag 18 shows a significantly lower mostly negative coefficeints for almost all spread
series.

Figure 3: Sample autocorrelation function with confidence bounds for credit spread returns up to 22 lags, categorized
by sector. Top left panel: Corp. Top right panel: Fin. Bottom left panel: Uti. Bottom right panel: Indu. Blue lines
indicate

To formally test for serial correlation in the spread return series we have conducted the Ljung-Box test, where
we have tested for 11, 22, 44 and ln(N) lags (N = 3468, ln(N ) 8). For all 13 spread return series the

23

Figure 4: Heatmap of sample autocorrelation coefficients for all credit spread return series up to 22 lags. The colorbar
right of the figure shows the size of the autocorrelation coefficient. Spread return series 1 to 13 are: Corporate,
Financials, Utility, Industial, AAA, AA, A, BBB, 1-3yrs, 3-5yrs, 5-7yrs, 7-10yrs and 10+yrs.

test statistic indicates siginificant evidence of serial correlation for all four lag lengths with p < 0.001. So in
line with indications from the ACF plots and the heatmap with sample autocorrelation coefficients discussed
earlier we can conclude that the spread return series are strongly autocorrelated over time.
Table 20 in the appendix shows an example of the autocorrelation matrix for a specific spread return
series up to 11 lags. If there had been no autocorrelation at all the matrix would only consists of ones on
the diagonal. In this case it is obvious that the square root of the sum of the autocorrelation matrix would

be equal to 11 3.32 and the square-root-of-time would hold. In this example, however, there is large
positive autocorrelation which results in the square root of the sum of the autocorrelation matrix equal to
approximately 5.62. Hence the positive autocorrelation is reflected in the scaling factor being larger than
what the square-root-of-time rule would give us.
Last, we use the Ljung-Box test to detect volatility clustering. We evaluate the squared spread returns
and test for 11, 22, 44 and ln(N) lags (N = 3468, ln(N ) 8). For all 13 spread return series the test
statistic indicates siginificant evidence of serial correlation for all four lag lengths, with p < 0.001. So it can
be concluded that there is definite evidence of volatility clustering in our spread return data.

24

4.3

Fitting the distribution

To estimate the parameters of the normal inverse Gaussian (NIG) probabililty density function (pdf) we use
maximum likelihood with the BFGS algorithm. Since we are dealing with univariate series this procedure is
not too complex and performs well. Especially since we are fitting the distribution using the parametrization
that is shown in the literature to converge properly as explained in section 2.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

0.101 (0.009)
0.051 (0.006)
0.107 (0.009)
0.152 (0.013)
0.087 (0.007)
0.066 (0.005)
0.060 (0.005)
0.046 (0.004)
0.046 (0.004)
0.109 (0.005)
0.026 (0.004)
0.034 (0.004)
0.038 (0.007)

0.015 (0.017)
0.008 (0.017)
0.011 (0.015)
0.021 (0.019)
0.007 (0.014)
0.005 (0.012)
0.004 (0.011)
0.005 (0.010)
0.003 (0.009)
0.006 (0.007)
0.001 (0.011)
0.004 (0.014)
0.003 (0.032)

-0.100 (0.135)
-0.095 (0.261)
-0.057 (0.126)
-0.106 (0.092)
-0.041 (0.154)
-0.028 (0.196)
-0.023 (0.214)
-0.034 (0.279)
-0.012 (0.283)
-0.015 (0.121)
-0.020 (0.561)
-0.072 (0.403)
-0.113 (0.354)

0.723
0.737
0.638
0.770
0.605
0.514
0.495
0.447
0.412
0.285
0.474
0.609
1.378

(0.049)
(0.068)
(0.045)
(0.043)
(0.047)
(0.049)
(0.050)
(0.054)
(0.052)
(0.028)
(0.073)
(0.074)
(0.108)

Table 2: Estimated parameters of NIG distribution

p for all 13 daily spread return series based on maximum likelihood
procedure. Standard error estimates based on

diag(H1 ) are shown in parentheses (H is the Hessian matrix)

Figure 5: Empirical pdf from the data, NIG pdf, normal pdf and Students t pdf for two credit spread returns series:
5-7yrs maturity (left panel) and BBB rating (right panel). The NIG, normal and Students t have been fitted to the
data using a maximum likelihood procedure

Figure 5 shows a comparison between three theoretical distributions and the empirical distribution for two
example spread series (5-7yrs maturity and BBB rated). The parameters for the normal distribution are:
1 = 0.013, 1 = 2.411, 2 = 0.002, 2 = 6.401. For Students t they are: 1 = 0.022, 1 = 0.454, 1 =
0.962, 2 = 0.104, 2 = 1.424, 2 = 1.260. Clearly the normal distribution does not give an accurate
25

description of reality, when compared to the empirical distribution which was to be expected. Both the fitted
Students t and NIG pdf are very close to the empirical pdf and seemed to indicate a good fit. A similar
picture is found for the other 11 spread return series that are examined in this paper so we can conclude that
the Students t-distribution and NIG distribution are a big improvement over the normal distribution. For
the NIG distribution, table 2 shows the parameter estimates for the daily spread return data. The standard
errors indicated in parentheses indicate that ML generally was able to fit the distribution well for and ,
while and gave more problems. The interpretation for is that daily spread returns are expected not to
be significantly different from zero. Table 21 in the appendix shows the parameter estimates when the NIG is
fitted on the monthly spread return data using ML. Here the standard errors are very high for all parameters
except which suggests the (other) parameters can probably not be trusted. This is likely to be caused by
the small number of monthly data points (Nm = 163). Especially a complicated four parameter distribution
such as the NIG needs more observations to properly be fitted to the data. All in all, these problems provides
more support for the need to investigate a way to construct a distribution for monthly spreads from scaling
a daily distribution.
To provide a more formal investigation of the accuracy of the theoretical distribution we have performed
the Kolmogorov-Smirnov (K-S) test. The K-S test is a nonparametric test of the null hypothesis that
the population cdf of the data is equal to the hypothesized cdf. Table 3 shows the p-values for the three
hypothesized distributions discussed earlier. It is again immediately clear that the normal distribution does
not suffice, with p < 0.001 for all 13 series. If we compare the outcome for the NIG and Students tdistribution we can draw very similar conclusions. Assuming = 0.05, we find a different result only for the
index of the utility sector, where the fitted Students t-distribution is rejected while the NIG distribution
is not. Although close, the p-values for the NIG distribution are, on average, slightly higher than for the
Students t, indicating a slightly better fit.
Interesting to note is that for all 13 spread series the estimated parameter lies far below the critical
value posed in Spadafora et al. (2014). They show that if lies below the critical value of 3.41, the Students
t-distribution does not scale in time. Since this is clearly the case for our spread return series this provides
additional reason to prefer the NIG distribution over the commonly used Students t, as the NIG distribution
does scale in time.
4.3.1

Subsamples

We fit the distribution on subperiods of the sample to compare the results for the estimated parameters.
We follow Eberlein et al. (2003) in taking 500 datapoints for parameter estimation. This means the total
daily sample, which includes 3468 data points, has been split up into seven periods of which the first six
include 500 data points and the last includes 468. Figure 6 shows the plots of the NIG pdfs fitted on all of
these seven subsamples and compared to the original NIG pdf fitted to the entire sample. As an example
the all corporate index serie is shown. From the figure it can be seen that the pdfs differ substantially when

26

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

NIG
0.221
0.040*
0.185
0.461
0.104
0.005**
0.001**
0.000**
0.000**
0.078
0.000**
0.018*
0.045*

Students t
0.068
0.034*
0.037*
0.065
0.101
0.020*
0.011*
0.000**
0.001**
0.085
0.009**
0.026*
0.005**

Normal
0.000**
0.000**
0.000**
0.000**
0.000**
0.000**
0.000**
0.000**
0.000 **
0.000**
0.000**
0.000**
0.000**

Table 3: p-values for K-S test for NIG, Students t and normal distribution shown for all 13 spread return series.
** indicates significance at the 5% level, * indicates significance at the 1% level. The K-S test shows whether the
population cdf of the data is equal to the hypothesized cdf of the three fitted distributions

estimated on different parts of the sample. The original pdf, estimated on the entire sample is shown in
black and compares well with those estimated on period 1, 4 and 7. For periods 2 and 3, the kurtosis of the
distribution is much higher, which indicates many more observations were found around the mean, which
in turn is in line with a more quiet period and relatively low daily changes in credit spread. On the other
hand, period 5 and 6 indeed show a much flatter distribution, indicating a much more volatile period with
positive and negative extreme spread changes. This period is associated with the financial crisis of 2008 and
afterwards.

Figure 6: NIG pdf fitted to 7 subperiods of the sample compared to the pdf fitted on the entire sample. Each
subperiod comprises of 500 observations, so P1 comprises of the first 500 observations, P2 the second 500 observations
etc. Results are shown for spread return series of Corp.

27

4.4

Empirical validation of scaling factor

Ultimately, the aim of this paper is to find an appropriate method for scaling the NIG ditribution, accounting
for non-zero autocorrelation in credit spread returns data. To evaluate the results we are looking at the scaling
of daily spread returns to monthly spread returns, since data is available for both horizons. In section 2 the
closure under convolution property of the NIG distribution is discussed and it is concluded that the sum
of NIG distributed random variables is NIG distributed. In particular, the parameters and remain
unchanged while and sum up. When we apply this property to scale an NIG distributed random variable
over time this means we would expect and to be multiplied by a factor t. All these theoretical properties
of course assume indepence (i.e. no autocorrelation).
To examine the empirical validity of these theoretical concepts and specifically applied to spread returns
data we are examining, a Monte Carlo simulation has been employed. Based on the daily spread return data
of our 13 indices we first fitted the NIG distribution as before. Table 2 shows the estimated parameters.
Then, using these estimated parameters, 10,000 daily spread returns were simulated, from which monthly
series have been constructed (assuming 22 trading days this resulted in 454 months or 38 years of data).
Instead of using the real daily data, we use simulated daily data because these are now independent. The
monthly series computed from the simulated data were used to again fit the NIG distribution. Now we can
compare the parameters estimated on the simulated monthly with the original parameters to evaluate the
scaling factor. As such, we have repeated the above explained exercise 100 times, effectively constructing 100
samples of 10,000 data points from which 100 scaling factors are computed. Table 4 shows the mean and
standard deviation of the computed scaling factors for the four NIG parameters.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Mean
23.027
22.104
23.267
25.666
22.678
22.467
22.811
22.485
21.967
22.479
22.391
22.272
23.138

Std. Dev.
4.771
3.066
4.641
16.859
3.215
3.001
2.923
2.477
2.468
2.726
1.998
2.530
3.263

Mean
25.402
22.509
26.956
44.095
21.130
29.109
25.509
25.119
24.667
24.060
23.070
21.364
24.572

Std. Dev.
18.639
14.658
27.406
170.971
28.054
34.579
45.624
21.985
50.243
32.134
40.659
12.466
23.395

Mean
1.084
1.037
1.102
1.592
1.065
1.046
1.078
1.057
1.042
1.080
1.083
1.045
1.077

Std. Dev.
0.300
0.215
0.270
4.285
0.203
0.233
0.222
0.218
0.222
0.234
0.213
0.184
0.205

Mean
1.200
0.953
1.266
3.985
1.058
1.237
1.004
1.255
0.919
1.188
1.459
0.905
1.026

Std. Dev.
0.955
0.730
1.275
25.893
1.287
1.478
1.654
1.080
1.588
1.995
2.843
0.885
1.235

Table 4: Simulated scaling factors for NIG parameters using estimated parameters for 13 spread return series as
basis. A total of 100 samples where simulated, each containing 10,000 simulated daily spreads. To compute monthly
data 22 trading days per month were assumed. The simulated scaling factors is then computed by dividing the mean
of the parameter for the simulated monthly sample with the mean parameter for the daily sample

On average, the results of the simulation experiment are compliant with the theoretical expectations. The
table shows that and scale with approximately 22 for most of the indices, while the scaling factor

28

for and lies close to 1. However, the industrial index deviates quite strongly from the theoretical value,
especially for and . The standard deviations associated with the scaling factors for this index are extremely
high, indicating untrustworthy results. An interesting result that applies to all indices is that the standard
deviations for the scaling of are much lower than for , although the means are relatively close. One
explanation for this could be that the values for lie very close to zero. Consequently, the possible error
in parameter estimation for monthly data can be blown up easily as the scaling factor is calculated through
division with the daily parameter (which is very small for the case of ). This phenomenon seems to be
reflected in the high standard deviaton for the scaling of . If we compare the results for the scaling of
and , we also see a larger standard deviation for on average. Again this could be the cause of parameters
for being generally smaller, casuing a bigger chance of errors.
The overall results from simulation are quite satisfactory, apart from the results for the industrial index.
Besides the fact that the standard deviation for is much higher than for , it might theoretically make sense
to constrain = 0 in any case, building on the assumption that credit spread changes should be roughly
zero in the long run. Taking both these considerations into account, we believe the empirical scaling of
should be leading in the validation of the various scaling factors computed in the next section. This result is
supported by the standard errors for estimating when fitting the NIG distribution to both daily and mothly
spread returns since these are the relative lowest.

Results

To calculate the scaling factors two different approaches will be investigated in this section. First, we will find
an appropriate model for credit spread returns from which we can calculate the scaling factor for scaling daily
to monthly returns. Second, rescaled range analysis and Hurst coefficient estimation will be used to calculate
scaling factors in a more direct manner. Third, these scaling factors will be used to construct monthly NIG
distributions which can then be compared with the real monthly distributions of credit spread returns.

5.1

ARFIMA(p,d,q) models

Initially, we started with two very simple models for credit spread returns: an AR(1) and an AR(1) plus
GARCH(1,1). However, the results immediately showed a bad fit with the data of spread returns and the
scaling factors computed from these models did not work very well. Therefore, the elaborate evaluation
of these models is shown in appendix A. A much better way of modeling credit spread returns is to use
ARFIMA(p,d,q) models which assumes an underlying fractal process. Let us therefore move to these results
directly.
For each of the 13 first differenced spread series, we estimate the long memory parameter d for nine
combinations of ARFIMA(p,d,q) models where p and q are between 0 and 2 and we choose the model which
minimises the Akaike Information Criterion (AIC). In general we implemented the Whittle estimator for

29

computing the parameters estimates as this proved to be computationally faster than the EML estimator of
Sowell. In addition, the EML estimator had more difficulties converging to the global minimum. However, for
some series the Whittle estimator did not converge in which case we used the EML estimator as alternative.
Table 5 shows the AIC values for the nine specifications of ARFIMA models ranging from a fractional
Brownian motion untill an ARFIMA(2,d,2) process. The parameters of the model were estimated using
the Whittle algorithm. The results show that for most spread return series the best model includes both
autoregressive and moving average terms. Interestingly though, for the 7-10 years maturity the best fit
is in fact the fBm. Overall, ARFIMA(1,d,2), ARFIMA(2,d,1) and ARFIMA(2,d,2) perform equally well,
providing the best fit to three series each. The ARFIMA(1,d,1) specifcation also performs well providing
the best fit to two series. Although including more AR and MA components in the model seems to lead
to a better specification, there are also problems associated with a more coplex model as the chance of
non-convergence increases with complexity. While the five simplest models converge for all time series, the
remaining four experience problems. Moreover, the difference between AIC values are extremely small for
most spread return series, indicating that the simpler models also suffice. Consequently, one could argue it
would in fact be better to go for a more parsimonious model with a low risk of convergence problems at a
small cost of accuracy of the fit. If we compare the models with just AR or just MA components, the pure
AR models outperform the MA models, especially when including two lags.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

(0,0)
2.824
3.592
2.694
2.586
2.843
2.787
2.775
2.838
2.719
1.760
3.525
3.696
4.718

(0,1)
2.811
3.778
2.696
2.572
2.847
3.000
3.016
3.073
2.745
1.755
3.526
3.701
4.718

(0,2)
3.262
3.982
3.221
3.150
3.020
2.930
2.888
2.947
2.835
1.749
3.648
3.834
4.737

(1,0)
2.812
3.572
2.680
2.576
2.841
2.787
2.775
2.837
2.718
1.756
3.512
3.696
4.715

(2,0)
2.812
3.572
2.680
2.572
2.838
2.784
2.774
2.836
2.718
1.753
3.509
3.696
4.713

(1,1)
2.806
3.567
2.874
2.563
2.778
2.768
3.094
3.226
3.511
6.359

(1,2)
2.807
3.568
2.679
2.563
2.831
2.776

(2,1)
2.807
3.567
2.678
2.563
2.829
2.785

(2,2)
2.806
3.567
2.881
2.564
2.836

3.182

2.832
3.533
1.746
3.509
3.814
4.708

2.833
2.718
1.747
3.508
3.702

1.746
3.872
4.858

Table 5: AIC values for nine ARFIMA(p,d,q) specifications with p and q between 0 and 2. Column headers represent
the p and q values of the ARMA part. When no value is shown, the Whittle estimation algorithm did not converge.
Bold indicates the lowest AIC value for a particular serie

For completeness the AIC values for the nine ARFIMA specifications based on the exact maximum likelihood
algorithm of Sowell are shown in table 23 in the appendix. For two series the EML algorithm converged while
the Whittle algorithm did not, but for the remaining seven models the algorithm did not converge either,
which means no parameters estimates could be found for those combinations of series and model specification.
Just like for the Whittle algorithm, all models including just AR or MA lags did converge. The best fit was
generally found for the ARFIMA(2,d,2) and ARFIMA(2,d,1) specifications, but interesting to note is that

30

for three spread series the ARFIMA(0,d,0) in fact proved to be the best fit.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Best Fit Whittle

ARFIMA(1,d,1)
ARFIMA(2,d,2)
ARFIMA(2,d,1)
ARFIMA(1,d,2)
ARFIMA(2,d,1)
ARFIMA(1,d,2)
ARFIMA(1,d,1)
ARFIMA(2,d,1)
ARFIMA(2,d,2)
ARFIMA(1,d,2)
ARFIMA(2,d,2)
ARFIMA(0,d,0)
ARFIMA(2,d,1)

dW
-0.053
-0.076
0.028
-0.285
-0.414
-0.224
0.261
-0.228
-0.151
-0.294
-0.255
0.078
-0.325

W
H
0.447
0.424
0.528
0.215
0.086
0.276
0.761
0.272
0.349
0.206
0.245
0.578
0.175

Best Fit EML

ARFIMA(1,d,1)
ARFIMA(2,d,2)
ARFIMA(2,d,2)
ARFIMA(2,d,1)
ARFIMA(2,d,2)
ARFIMA(0,d,0)
ARFIMA(0,d,0)
ARFIMA(2,d,1)
ARFIMA(2,d,1)
ARFIMA(1,d,2)
ARFIMA(2,d,2)
ARFIMA(0,d,0)
ARFIMA(2,d,1)

dE
-0.053
-0.075
-0.015
-0.313
0.053
0.025
0.007
-0.222
-0.163
-0.294
-0.255
0.078
-0.325

E
H
0.447
0.425
0.485
0.187
0.553
0.525
0.507
0.278
0.337
0.206
0.245
0.578
0.175

Table 6: Estimates of long memory parameter d and corresponding H for the model that provided the best fit
according to the Whittle alrgorith (left) and EML algorithm (right) for all spread return series
Table 6 shows the estimated fractional integration coefficient d and the associated Hurst exponent for the
two estimation procedures of the model that provided the best fit. First, we can notice that all values lies in
the desired range of 12 < d < 12 . However, the estimated values for d are almost all negative, especially for
dW . The more AR and MA terms included in the model, accounting for the short term effects of the spread
returns, the lower the estimate of d seems to be. In that sense, the short term autocorrelation effects are
taking away from the long memory that might exist in the serie. Although this could be the case theoretically,
this is not what you would expect, since the associated Hurst exponents become much lower than 21 . Since
both algorithms had problems converging for ARFIMA models with several AR and MA lags included, we
could take caution with interpreting the results for such models. Although all the models depicted in the
table did converge, it may well be a local minimum rather than the global minimum, which would provide us
with incorrect results. If we examine the series for AAA rated, AA rated and A rated in specific, we notice
that the two algorithms proposed a very different model specification as best fit. As a result, the estimated
coeffients for d and H are also very different for these series. This strongly indicates untrusthworthiness of
the results.
Since we believe it is important to be sure the estimates produced by the two estimation algorithms are
correct, we propose an alternative approach to the best fit for determining the correct model specification.
We discard all the models for which either of the algorithms did not always converge, since this also indicates
possible incorrect result for those series for which it did converge. Instead, we look at the estimates provided
by the two algorithms and use those for which the results are very similar.
In reality this means we immediately discard all models including both AR and MA lags, since for
all these models some series did not converge. For ARFIMA(0,d,0), ARFIMA(1,d,0), ARFIMA(2,d,0),
ARFIMA(0,d,1), ARFIMA(0,d,2) the estimates for d using both algoritms are shown in table 7. In the
table, d00
W indicates the estimated value for d in the ARFIMA(0,d,0) model specification based on the Whit31

tle algorithm. The results show that for ARFIMA(0,d,0), ARFIMA(1,d,0), ARFIMA(2,d,0) all estimates of
d are identical for both algorithms. For ARFIMA(0,d,1) roughly half of the series give identical values for d
coming from the two algorithms, but some are substantially different. Taking a closer look, we may notice
that several estimates are exactly 0.5, which is the upper boundary of d. This suggests that the algorithm
might not have converged to the true minimum, but instead stopped at the boundary level in order not to
violate the constraint. For ARFIMA(0,d,2) many more series indicate the same problem, for both estimation
algorithms. As mentioned before, we would rather choose a simpler model, for which we can trust the estimates produced by the two algorithms, instead of a more complex model that might provide incorrect results.
Therefore, we decide to base our scaling factor on the ARFIMA(0,d,0), ARFIMA(1,d,0) and ARFIMA(2,d,0)
model specifications.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

d00
W
0.165
0.122
0.065
0.148
0.053
0.026
0.007
-0.004
-0.033
-0.084
0.063
0.078
0.075

d00
E
0.165
0.122
0.065
0.148
0.053
0.025
0.007
-0.004
-0.033
-0.084
0.063
0.078
0.075

d10
W
0.253
0.234
0.162
0.225
0.010
-0.002
0.005
-0.036
-0.069
-0.038
-0.053
0.094
0.023

d10
E
0.252
0.233
0.162
0.224
0.010
-0.002
0.005
-0.037
-0.069
-0.038
-0.053
0.094
0.023

d20
W
0.267
0.251
0.149
0.280
0.046
0.033
0.029
-0.013
-0.043
0.001
-0.012
0.111
0.055

d20
E
0.268
0.253
0.150
0.281
0.047
0.033
0.029
-0.013
-0.042
0.001
-0.012
0.111
0.055

d01
W
0.289
0.287
0.184
0.285
0.007
-0.245
0.500
-0.038
-0.070
-0.014
0.073
0.130
0.022

d01
E
0.291
0.500
0.085
0.288
0.007
-0.245
0.500
0.500
-0.146
-0.014
0.073
0.130
0.082

d02
W
0.318
0.289
0.167
0.377
0.075
0.500
0.500
-0.008
-0.042
0.102
0.500
-0.132
0.063

d02
E
-0.122
-0.178
-0.017
-0.023
0.500
0.500
0.500
0.500
0.500
0.102
0.500
-0.132
0.174

Table 7:

Estimated values for long memory parameter d, based on Whittle and EML algorithms, for the
ARFIMA(0,d,0), ARFIMA(1,d,0), ARFIMA(2,d,0), ARFIMA(0,d,1), ARFIMA(0,d,2) specifications. d00
W means the
estimated value for d in the ARFIMA(0,d,0) model based on the Whittle algorithm

Now that we have established which results to trust, we can interpret the outcomes for our three models.
Table 7 shows us the estimates for d, from which we can see the value lie between 0 and

1
2

for most series.

This indicates long memory, even when short-term autoregressive effects are accounted for. Interestingly, the
estimated parameter for d increases - for several series - when one or two AR lags are included.
In table 8 we find the estimated parameters and significance for the three ARFIMA models we are evaluating. The table shows the estimates based on the Whittle algorithm, as this proved to be computationally
faster, but results can be expected to be almost identical for the EML estimator, as we already saw in table
7. We note that practically all parameters are found significant at the 1% level, except for some model specifications for the AA, A and BBB rated series. In general, the ARFIMA(2,d,0) specification find significant
parameters estimates for all series, which indicates this model provides a good fit. The AR coefficents are
generally negative, when associated with a positive estimate for d. This could mean that the two terms are
interacting and possibly affecting the estimates for d and subsequently for H. For BBB rated and 1-3 years
maturity all three models provide negative estimates of d, indicating a short memory process. For 3-5 years

32

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

d00
0.165*
0.122*
0.065*
0.148*
0.058*
0.026*
0.007**
-0.004
-0.033*
-0.084*
0.063*
0.078*
0.075*

00
H
0.665
0.622
0.565
0.648
0.553
0.526
0.507
0.496
0.467
0.416
0.563
0.578
0.575

d10
0.253*
0.234*
0.162*
0.225*
0.010**
-0.002
0.005
-0.036*
-0.069*
-0.038*
-0.053*
0.094*
0.023*

10
H
0.753
0.734
0.662
0.725
0.510
0.498
0.505
0.464
0.431
0.462
0.447
0.594
0.523

10
1
-0.164*
-0.207*
-0.178*
-0.148*
0.075*
0.051*
0.004
0.057*
0.061*
-0.091*
0.186*
-0.029*
0.089*

d20
0.268*
0.253*
0.150*
0.281*
0.047*
0.033*
0.029*
-0.013**
-0.042*
0.001
-0.012*
0.111*
0.055*

20
H
0.768
0.753
0.650
0.781
0.547
0.533
0.529
0.487
0.458
0.501
0.488
0.611
0.555

20
1
-0.181*
-0.228*
-0.164*
-0.212*
0.042*
0.019*
-0.019*
0.035*
0.036*
-0.136*
0.155*
-0.046*
0.061*

20
2
-0.022*
-0.027*
0.018*
-0.087*
-0.064*
-0.064*
-0.043*
-0.040*
-0.041*
-0.071*
-0.068*
-0.027*
-0.053*

Table 8: Estimated parameters for ARFIMA(0,d,0), ARFIMA(1,d,0) and ARFIMA(2,d,0) based on the Whittle
the associated Hurst exponent (H
= d + 1 ) and i is the AR
algorithm. d is the fractional integration parameter, H
2
coefficient for lag i. * indicates significance at the 1% level and ** indicates significance at the 5% level
maturity, 5-7 years maturity and AA rated index series the results are ambiguous between the three models.
For all other series the three ARFIMA specifications provide positive estimates of d, indicating long memory.
The easiest way to move from having estimated the ARFIMA model to computing a scaling factor would
be to simply use the formula S = 22H and plug in the estimated Hurst coefficient for the different ARFIMA
models. However, this is incorrect. To understand why, it must be noted that this simple formula stems
from the autocorrelation function of the fractional Brownian motion. If we use the theoretical scaling factor
in case of autocorrelation, as shown in 2, we get
v
u
k1
u
X
S = tk +
2(k i)(i)
i=1

for a k-day horizon, as mentioned before. Pluggin in the autocorrelation fucntion for a fBM results in the
same scaling factor as S = k H . However, we have now estimated an ARFIMA(p,q,d) for p equal to 0, 1
or 2. Therefore, we have to make use of the autocorrelation function of an ARFIMA(p,q,d) process, as was
defined in section 3.3.3. Although the results are comparable, the simple formula slightly overestimates the
scaling factor as compared to the theoretically correct scaling factor based on the autocorrelation fucntion of
an ARFIMA process.
Table 9 shows the resulting scaling factors based on the three ARFIMA specifications. The first thing we
notice is the direct relation between the scaling factor and the estimated value for d. In general, the values
for d are slightly higher for the ARFIMA(2,d,0) than for the ARFIMA(1,d,0) and ARFIMA(0,d,0) models

which results in higher scaling factors. Compared to the square-root-of-time rule ( 22 = 4.69) the scaling
factors are much higher because the positive autocorrelation is incorporated.
Next, let us simulate the three ARFIMA processes and compare the sample scaling factors from these
simulated spread returns with the theoretical scaling factors obtained. We do so by simulating daily spread

33

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

SARF 00
7.465
6.595
5.600
7.110
5.418
5.027
4.785
4.639
4.295
3.763
5.581
5.818
5.766

SARF 10
8.725
7.923
6.412
8.039
5.178
4.894
4.774
4.501
4.161
3.871
4.915
5.935
5.431

SARF 20
8.941
8.169
6.326
8.796
5.216
4.915
4.797
4.513
4.179
3.908
4.913
5.995
5.478

Table 9: Scaling factor based on autocorrelation function for ARFIMA processes. SARF 00 is the estimated scaling
factor from the ARFIMA(0,d,0) process, SARF 10 is the estimated scaling factor from the ARFIMA(1,d,0) process and
SARF 20 is the estimated scaling factor from the ARFIMA(2,d,0) process

returns for the three ARFIMA models we are evaulating (N = 1,100,000). From simulated daily returns
monthly returns can then be computed by adding up blocks of 22 returns. Next, a scaling factor can be
computed
r by dividing the monthly sample variance over the daily sample variance and taking the square root
2
m
(S =
2 ). We repeat this simulation 1,000 times to obtain a distribution of 1,000 simulated scaling factors.
d

We can then compare the theoretical scaling factors shown in table 9 with this distribution. These results
for the ARFIMA(0,d,0) are shown in figure 7. For all 13 spread series we find the theoretical scaling factor
almost exactly in the middle of the distribution of simulated scaling factors, indicating that is is computed
properly.
However, the results for the ARFIMA(1,d,0) and ARFIMA(2,d,0) are not as satisfying. The theoretical
scaling factor lies far from the mean of the dsitribution for both models, as shown in figure 14 and 15
in the appendix. This indicates that the theoretical scaling formula from equation 2 does not work well
from ARFIMA models with higher order lags. This can be caused by the complexity of the autocorrelation
function (acf) for these models, which is needed to compute the theoretical scaling factor. For the simple
fractal process, with no AR lags, the acf is not hard to compute, but for fractal processes with AR lags the
autocorrelation factors have to be approximated numerically. The inaccuracy in this approximation may be
the cause of the inaccuracy of the scaling factors for these ARFIMA models. In the figures, we have also
plotted a green line which shows a scaling factor computed as S = 22H where H = d+ 0.5 from the ARFIMA
models. Although this is theoretically invalid, the results are not dependent on the autocorrelation function
and provide slightly better results, although still very inaccurate.

5.2

Hurst coefficient estimation

From the literature various methods for estimating the Hurst coefficient have been elaborated on in detail in
section 3. Let us now compare the results between these estimators for our dataset of credit spread return
34

Figure 7: Distribution of scaling factors from Monte Carlo simulation for ARFIMA(0,d,0) process. 1,100,000 daily
spread returns were simulated 1000 times to construct 1000 scaling factors using the relation between the monthly
and daily sample variance. The red line shows the theoretical scaling factor as computed from equation 2.

series. Table 10 shows the Hurst coefficients for various methods. We have investigated four versions of
n , Moody-Wus modified Q
n and the Anisrescaled range analysis: the original Qn by Hurst, Los modified Q
Lloyd-Peters expected E(Qn ). In addition, the generalized Hurst exponent (GHE) approach is included in
the results.
From the table it can be seen that the traditional Hurst rescaled range analysis provides the lowest estimates
of H on average. If we compare with Lo and Moody-Wus estimates it seems reasonable to conclude that it
probably underestimates it as a result of short-term autocorrelation present in the data. These two modified
versions of the rescaled range statistic Qn both account for this short-term bias present in the data, which
result in significantly higher estimates. For the indices with relatively low autocorrelation (see table 19) such
as AAA, AA and A we also find that Los modified statistic deviates less from the traditional Hurst coeficient,
while the differences for indices with higher autocorrelation are slightly bigger. Anis-Lloyd-Peters E(Qn )
statistic produces estimates that lie closes to the traditional estimates although the differences are small. If

35

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

H
H
0.669*
0.643
0.637
0.696*
0.560
0.577
0.574
0.571
0.533
0.544
0.555
0.649
0.655

Lo
H
0.713*
0.685*
0.678*
0.733*
0.587
0.613
0.613
0.620
0.581
0.577
0.595
0.694*
0.694*

MW
H
0.737*
0.710*
0.703*
0.757*
0.613
0.639
0.639
0.644
0.607
0.604
0.620
0.719*
0.718*

ALP
H
0.6748
0.664*
0.645*
0.658*
0.625*
0.595*
0.591*
0.538
0.566
0.570
0.572
0.613*
0.5938

GHE
H
0.704 (0.024)*
0.676 (0.028)*
0.597 (0.023)*
0.693 (0.029)*
0.526 (0.015)
0.502 (0.017)
0.491 (0.018)
0.467 (0.010)
0.450 (0.011)
0.418 (0.039)
0.510 (0.007)
0.574 (0.021)*
0.549 (0.012)*

Table 10: Estimated Hurst coefficients for all 13 spread return series using various methods. * indicates significantly
H , H
Lo and H
M W we use the confidence interval
different from 21 at the 5% level, i.e. long-range dependence. For H

GHE
of Couillard and Davison (2005). For HALP we use the empirical confidence interval of Weron (2002). For H
the traditional standard error estimator from Di Matteo et al. (2003) is used and standard errors can be found in
brackets.

we turn to the results for the GHE approach we find that estimates are subtantially different. Interestingly,
the GHE approach produces H coefficients that are substantially smaller and larger than the traditonal
rescaled range anlysis does. The estimates seem to be smaller for the indices with low autocorrelation and
higher for those with large autocorrelation, but the exact relation is not immediately clear.
One of the drawbacks of rescaled range analysis is that there is no asymptotic distribution theory available
for H (Weron (2002)). Therefore, we cannot construct a statistical test for significance of the estimated Hurst
exponents. Nevertheless there is literature available on empirical acceptance regions for testing the null
hypothesis that H = 0.5, i.e. no long-range dependence. For the traditional Hurst statistic Los modification
and Moody and Wus modification, we follow Couillard and Davison (2005) in using

1
1

eN 3

as estimated

standard deviation, which results in a 95% confidence interval of [0.3415; 0.6585]. For the Anis-Lloyd-Peters
corrected R/S statistic we use the empirical confidence interval of Weron (2002). For our sample this results
in [0.4094; 0.5860]. For GHE we use the standard errors as computed following Di Matteo et al. (2003) to
compute the 95% confidence interval. Since this is the only Hurst estimator that can use distributional
properties to compute standard errors the confidence interval is computed for all spread series separately and
the standard errors can be found in table 10.
For the spread series categrorized by sector most Hurst estimators suggest significant long-range dependence, especially for the Industrials. The series categrorized by rating do not show signs of long-range
dependence as the estimated Hurst coefficients lie close to 0.5. If we compare the methods of calculating the
coefficient we also see that the traditional Hurst estimator is least often significant, while modifications of
Lo and MW increase the number of significant spread series. This can be due to the bias in Hursts statistic
as a result of short-range correlations, which were found present in most of the spread series. Lo and MWs
modifications account for such serieal correlation in the data in assesing the long-range dependence.

36

Now let us examine the scaling factors that result from our estimated Hurst coefficients. Table 11 shows
these factors for the five methods we employed, as well as the empirical scaling factor with which we can
compare. This empirical scaling factor is defined as the ratio between the estimated parameter of the NIG
distribution for the monthly and daily spread returns series. The rationale behind this has been explained in
section 4.4. The scaling factor based on the Hurst coefficient has been calculated as 22H . For comparison,

we note that the square-root-of-time would provide us with a scaling factor of 22 = 4.69.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs
Mean Diff.
Std. Dev. Diff.

SH
7.841
7.231
7.092
8.498
5.602
5.904
5.842
5.788
5.157
5.328
5.515
7.364
7.503
-0.274
1.430

SLo
8.956
8.232
8.049
9.527
6.078
6.589
6.586
6.729
5.979
5.893
6.227
8.450
8.467
0.580
1.277

SM W
9.652
8.892
8.700
10.260
6.581
7.130
7.134
7.260
6.462
6.407
6.736
9.119
9.112
1.171
1.220

SALP
7.953
7.721
7.272
7.579
6.830
6.238
6.163
5.234
5.696
5.777
5.818
6.588
6.199
-0.243
1.973

SGHE
8.729
7.991
6.279
8.423
5.046
4.677
4.528
4.211
3.992
3.614
4.800
5.849
5.414
-1.128
1.690

Semp
9.377
8.073
7.966
8.514
3.880
6.108
6.196
5.439
4.324
3.679
4.509
10.082
10.073

Table 11: Estimated scaling factor for all 13 spread return series based on Hurst coefficients estimated with various
methods. Semp is the empirical scaling factor from simulation as explained in section 4.4. Below the table the mean
and standard deviation of the difference with the empirical scaling factor are shown for the five estimated scaling
factors

The table shows the scaling factors as well as the mean and standard deviation of the difference with the
empirical scaling factor. If we look at the classical Hurst estimation approach we find that it performs
quite well. Although it slightly underestimates the scaling factor on average, there is only one method that
produces a lower mean difference. This is the Anis-Lloyd-Peters corrected Hurst coefficient. However, the
standard deviation of the differences is the highest of all the methods, indicating it cannot be applied to every
series wtihout close inspection of the results. Los modified rescaled range analysis provides a good balance
between a low average difference as well as a lower standard deviation of the differences than the other two
methods mentioned. Although the GHE approach was mentioned in the literature as preferable, it performs
very poorly for our sample of spread returns. It heavily underestimates the scaling factor and also produces
very volatile results.
Overall, we can see that methods making use of the Hurst coefficient produce much better scaling factors
than the square-root-of-time, which heavily underestimates the scaling for most indices. Interesting to note is
that the two bond indices with high maturitiees (7-10 years and 10+ years) have very high empirical scaling
factors, which are not accurately estimated by most methods. Only the MW approach provides estimates
that come close, but this method generally overestimates the scaling factor quite heavily for the other indices.

37

5.3

Scaling the distribution

The two-sample Kolomogorov-Smirnov (K-S) test is a nonparametric hypothesis test that evaluates the
difference between the cumulative distribution functions (cdfs) of the distributions of two samples over the
range of x in each sample (Massey Jr (1951)). It uses the maximum absolute difference between the cdfs of
the two distributions, which give the following test statistic


D = max |F1 (x) F2 (x)|
where F1 (x) and F2 (x) is the proportion of values less than or equal to x, in sample 1 and 2 respectively.
Based on the five different estimators of the Hurst exponent, as have been discussed in section 3, we
construct the scaling factor as S = 22H . In addition, the three scaling factors based on the ARFIMA models
are computed. Next, using the closure under convolution property of the NIG distribution, we scale the
distribution fitted on the daily spread returns by multiplying and with the scaling factor S. We then
simulate 1,000,000 values from this scaled NIG distribution and use the two-sample K-S test to compare this
simulated sample with the true monthly spread return sample. In theory one could also simulate from the
NIG distribution fitted on the monthly sample, however we decided not to do this because the estimated NIG
parameters for the monthly sample are less trustworthy. As a result, a large simulation from this estimated
distribution might lead to a blowing up of errors in the estimated parameters leading to possible incorrect
conclusions. Therefore it is better to compare the simulated sample directly with the monthly sample. Table
12 shows the p-values for the two-sample K-S test for all 13 spread returns series. Significant p-values indicate
rejection of the null hypothesis that the two sample come from the same hypothesized distribution. While
these p-values are truly correct only assymptotically, we can assume they are accurate if samples n1 and n2
satisfy (n1 n2 )/(n1 + n2 ) 4, which is clearly the case here (Massey Jr (1951)).
If we look at the results for the various estimators of the Hurst exponent, it is immediately evident that
all of them improve on the square-root-of-time rule (SRTR). When scaling the distribution with the SRTR,
9 out of 13 rescaled distrbution reject the null hypothesis at the 1% level. Moreover, for the four indices
that do not reject the null hypothesis when scaled with the SRTR we can see in table 11 that in fact these

indices have an empirical scaling factor that lies around the scaling factor of the SRTR: 22 = 4.69. So
rather than concluding that the SRTR performs well for these indices it more appropriate to attribute this
result to coincidence. In addition, the scaling factors based on the hurst exponent perform equally well or
better for all indices except the 3-5yrs maturity index.
The generalized hurst exponent (GHE) estimation approach performs only slightly better than the SRTR.
It improves on it with only one index for which the scaled distribution is found insignificantly different from
the true monthly distribution at the 5% level. The classical rescaled range analysis method as introduced by
Hurst also improves for only one index at the 5% level when compared with the SRTR. However, if the more
strict 1% level of significance is adopted, five additional indices are found insignificant, indicating that the

38

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Hurst
0.002*
0.0058
0.026**
0.000*
0.135
0.061
0.024**
0.549
0.355
0.043**
0.435
0.044**
0.014**

Lo
0.008*
0.008*
0.085
0.001*
0.143
0.146
0.052
0.431
0.134
0.022**
0.213
0.127
0.033**

MW
0.011**
0.010*
0.126
0.002*
0.090
0.243
0.090
0.281
0.075
0.012**
0.128
0.169
0.050

ALP
0.003*
0.006*
0.032**
0.000*
0.071
0.096
0.035**
0.448
0.179
0.022**
0.320
0.012**
0.002*

GHE
0.007*
0.007*
0.006*
0.000*
0.073
0.008*
0.004*
0.133
0.172
0.118
0.398
0.003*
0.000*

ARF00
0.001*
0.004*
0.001*
0.000*
0.114
0.015**
0.006*
0.275
0.219
0.152
0.381
0.003*
0.001*

ARF10
0.007*
0.007*
0.008*
0.000*
0.085
0.012**
0.006*
0.217
0.199
0.181
0.445
0.003*
0.000*

ARF20
0.008*
0.007*
0.006*
0.000*
0.090
0.012**
0.007*
0.225
0.200
0.185
0.434
0.004*
0.000*

SRTR
0.000*
0.001*
0.000*
0.000*
0.049**
0.008*
0.006*
0.300
0.298
0.113
0.358
0.000*
0.000*

Table 12: p-values of two-sample Kolmogorov-Smirnov test based on scaling factors using Hurst exponent estimators
and ARFIMA models compared with the square-root-of-time rule (SRTR). The test checks whether the scaled daily
spread return data comes from a signicantly different distribution as the monthly spread returns. ** indicates significance at the 1% level and * indicates significance at the 5% level. ARF00 shows results based on the ARFIMA(0,d,0)
model, ARF10 for the ARFIMA(1,d,0) model and ARF20 for the ARFIMA(2,d,0) model

scaled distribution is only truly incorrect for 3 out of 13 spread return indices.
For the other three hurst exponent estimators based on rescaled range analysis, the best results come
from the Moody-Wu modification of the Qn statistic. Los modified version provides five indices for which
the scaled distribution is found to be significantly different from the true monthly distribution at the 5%
level, but only three at the 1% level. Anis-Lloyds version also gives decent results, with seven significant
differences at the 5% level and four at the 1% level. Nevertheless, the scaling factor based on Moody-Wus
rescaled range analysis results in 13 scaled NIG distributions, of which only one is found significantly different
from the true monthly distribution at the 1% level and four at the 5% level.
If we turn to the scaled distribution based on the ARFIMA scaling factors, we find that all three models
perform equally well, with 7 significant spread series at the 1% level and one significant serie at the 5% level.
This means they improve on the SRTR by only one serie. Between the ARFIMA models, the differences are
marginal.
One could argue that in fact it is most appropriate to use the more strict 1% level for testing significance,
since several factors of uncertainty are part of the process of the construction of the scaled distribution. First,
the true distribution of the monthly spread returns with with the scaled distribution is compared is quite
uncertain, as we only have 163 monthly data points. Second, the parameters of the NIG distribution are
estimated on 3469 daily spread returns. Although this is a reasonable number there will still be some error
margin, which will influence the scaling of the distribution. Last, the simulation could impact the results for
the K-S test. As a robustness check, the K-S test was also performed based on a data sample of 1,000, 10,000
and 100,000 simulations, but the same conclusions would be drawn as for 1,000,000 simulations discussed
above.
Now that we have evaluated a variety of methods for scaling the NIG distribution fitted on daily data to

39

Figure 8: NIG probability density function for empirical monthly spread returns (red), daily spread returns scaled
with the SRTR (blue) and daily spread returns scaled with MW scaling factor (black)

a monthly horizon, let us compare the results with the NIG distribution fitted on the actual monthly spread
returns. Figure 8 shows the NIG probability density function for the empirical monthly spread returns in
red, the NIG probability density function based on daily spread returns scaled with the SRTR in blue and
the NIG probability density function based on daily spread returns scaled with scaling factor from the Hurst
exponent estimated with Moody and Wus rescaled range analysis in black.
For the majority of the spread return series the figure shows a better fit for the MW scaling factor as
compared to the SRTR. It significantly improves on the SRTR for the sector-based return series, as we can
see that the black distribution lies much closer to the red distribution than the blue distribution. For AAA
rated, 1-3 years maturity, 3-5 years maturity and 5-7 years maturity the SRTR shows a slightly better fit,
but from table 12 we know that the MW scaling factor still provides satisfying results. The result for the
rating-based return series are relatively close between the SRTR and MW scaled distributions. This can
be explained by the fact that for most of these series, the estimated Hurst exponent was not found to be
significantly different from 12 in which case the SRTR is also valid.

40

Backtesting

To evaluate the scaling factors and the corresponding scaled distributions we will backtest the results on
historical data. The procedure for doing so will now be explained.
First, the NIG distribution is fitted to the daily spread return data and the scaling factor is calculated
using a variety of methods that have been explained earlier. From this we can construct a scaled distribution
for monthly spread returns. Then we use Monte Carlo simulation to simulate a large amount of monthly
spread data (e.g. N = 1,000,000). From this simulated data we can then extract the Value at Risk (VaR)
using the empirical quantile. For example, the 99% VaR is found by sorting the simulated data and taking
the 1% lowest value. Last, we can compare this VaR with the historic monthly data and evaluate the number
of violations. If we use this method, the VaR value is static and based on the entire sample.
Alternatively, we can create a dynamic model, in which the VaR is based on a subset of values up to the
point at which it is evaluated. For example, if we use the past 20 months as frame of reference this method
works in the following way. Starting from month 20, we use the past 20 months of daily data (approximated
by 20 21) to fit the NIG distribution and to construct the scaling factor. The distribution is then scaled to
a monthly spread return distribution, from which a large number of monte carlo draws are taken. These are
used to find the empirical 1% quantile - the 99% VaR - which is compared to the historical value for that
month. The next month, a new distribution and scaling factor are estimated from the past 20 months of daily
data. A new distribution for monthly data is constructed, monte carlo simulation is used to obtain VaR and
this is again compared to the historical loss for that month. This is repeated untill we arrive at the last month
of the dataset. Although this dynamic method is much more accurate in adapting to specific situations, it is
obivously very computationally demanding since the whole procedure is repeated every monthly datapoint.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Hurst
14
13
12
16
9
11
7
8
1
6
6
10
10

Lo
13
9
11
16
9
9
6
5
1
6
6
10
10

MW
12
9
11
16
9
9
6
5
1
5
6
10
10

ALP
14
13
12
17
9
10
7
8
1
6
6
10
12

GHE
14
11
13
17
9
12
9
9
3
8
6
11
12

ARF00
14
14
15
18
9
12
9
8
3
8
6
11
12

ARF10
14
13
13
17
9
12
9
8
3
8
6
10
12

ARF20
13
9
13
16
9
12
9
8
3
7
6
10
12

SRTR
23
18
16
21
9
12
9
8
2
6
6
12
13

Table 13: Number of violations of 99% VaR based on Monte Carlo simulation from scaled monthly NIG distribution
using nine different scaling factors. A static method is used based on the entire sample

Let us start with the VaR based on a static distribution. For this method, the distribution for daily spread
returns and the scaling factos is estimated on the entire sample, from which a distribution for monthly spreads

41

has been constructed. The 99% VaR is the computed using simulation from this distribution and by looking
at the empirical quantile. Table 13 shows the number of violations if we backtest the results with historical
monthly spread returns.
Clearly the number of violations is much too high. For N = 163 we would expect 99%VaR to be violated
one or two times. This is only the case for one spread serie with only four scaling factors. So we see that the
risk is severely underestimated using this method. However, when we compare the results to the square-rootof-time rule (SRTR) all eight scaling factors outperform this standard scaling method. This indicates there is
a definite improvement to be made from calculating a scaling factor that accounts for serial correlation effects
over the SRTR. Moody and Wus modified rescaled range analysis perfoms best with the lowest number of
violations for all 13 spread series. Table 24 in the appendix shows the results for 95% VaR. Similarly, the
number of violations is much higher than it should be, but the scaling factors all outperform the SRTR. The
MW scaling factor also performs best here.
To illustrate the backtesting results figure 9 shows the historical losses, 99%VaR and violations for the
credit spread returns with 10+ years maturity using the MW scaling factor. The figure clearly shows that most
violations are found in clusters and occur during the period of the financial crisis and the years afterwards.
Only one violation of 99%VaR is found before this period, which shows that although it used to be an accurate
method of risk management it heavily underestimates the possibility of extreme losses. While this is just an
example of one spread serie using one scaling factor, similar pictures are found for other series and scaling
factors.

Figure 9: Backtesting results from MC simulation based on entire sample (static method) using the MW scaling
factor. Historic losses (in basis points), 99%VaR and violations are shown for credit spread index return serie with
10+ years maturity

42

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Hurst
15
10
16
18
11
11
10
9
3
7
12
15
14

20 months
Lo MW ALP
12 11
13
9
9
9
16 15
11
16 16
18
10 9
9
9
8
10
8
7
9
7
7
9
1
1
3
7
6
7
11 10
11
15 15
16
10 10
17

GHE
16
13
17
18
14
13
12
12
8
10
13
17
21

Hurst
10
9
15
13
11
12
12
11
8
9
12
14
15

50 months
Lo MW ALP
10 10
10
8
8
8
15 15
12
13 13
13
11 11
11
12 12
12
11 11
11
10 9
10
5
4
5
8
7
7
12 12
12
14 14
14
12 12
14

GHE
10
10
15
14
13
15
14
11
10
12
13
14
16

Table 14: Number of violations of 99% VaR based on Monte Carlo simulation from scaled monthly NIG distribution,
using five different scaling factors. A dynamic (conditional) method is used with a 20 months and 50 months window
for estimation

Next, let us look at the results for the dynamic method where the distribution and scaling factor are recalculated every month based on a certain window of past observations. Table 14 shows the results for the 5
scaling factors using either a 20 months or 50 months window for estimation. We have only examined the
scaling factors based on Hurst exponent analysis and rescaled range analysis, because the monthly estimation of ARFIMA models becomes computationally much too demanding. However, in the static method we
have seen that most scaling factors based on the former outperform the latter, so we believe the best results
will still be obtained in this way. For 99%VaR we see again that the violations are much too high, severly
exceeding the expected number of one or two. When we compare the results for a 20 month window and a
50 month window it is difficult to conclude which works better. For the first half of the spread series the
50 months seems to perform better while the second half works better for 20 months. In general it remains
ambiguous which should be used. Just like with the static method, the MW scaling factor performs best for
both dynamic methods. Similar results are shown for 95%VaR in table 25 in the appendix. As a robustness
check, we also performed a hybrid method of backtesting, where the distribution is re-estimated every month
based on a window of past observations, but the scaling factor is held constant. Tables 26 and 27 in the appendix show the results for both 95% and 99% VaR based on the past 20 and 50 months. Similar conclusions
can be drawn from the results of this hybrid method.
Figure 10 shows the historical losses, 99% dynamic VaR based on the past 20 months using the MW
scaling factor and the violations for 10+ years maturity spreads returns. The picture clearly shows how the
VaR adapts to the volatile periods, but with a large lag causing many violations to occur in the 2008 crisis
period. The last couple of years the VaR is relatively high and no more violations occur.
When comparing the two methods we find that the static method outperforms the dynamic method,
independent of the size of the window of estimation. This can be attributed to the fact that the dynamic
method will need some time to adapt to more volatile periods such as the financial crisis in 2008. Before this
43

Figure 10: Backtesting results from MC simulation based on window of past 20 months (dynamic method) using the
MW scaling factor. Historic losses (in basis points), 99%VaR and violations are shown for the credit spread return
serie with 10+ years maturity.
time the 99%VaR will not be very strict, because relatively little large losses are observed. Once the crisis
hits, the dynamic method takes quite some time to incorporate these losses and will incur a lot of violations.
The static method incorporates these large losses immediately, since it estimates VaR over the entire period.
The downside of static VaR is that it will be much higher in calm periods than is probably necessary.

7
7.1

Conclusion
Summary of main findings

Within the Solvency II framework credit spread risk is an important risk factor used for the internal modeling
by insurers to calculate Solvency capital requirements (SCR). One of the biggest issues with constructing
one-year VaR is the lack of yearly data, which causes many to use the square-root-of-time to scale their
results. However, this rule only holds under the assumption of independence and identical distribution of
returns. This is hardly ever the case for financial data and credit spread returns in particular. This paper has
contributed to the gap in the literature on constructing an appropriate scaling factor for credit spread returns
in case of autocorrelation in the data. This scaling factor has been applied to a normal inverse Gaussian
(NIG) distributional framework of credit spread risk modeling. Empirical results have been compared for the
scaling of daily to monthly credit spread returns. We investigated the scaling between daily and monthly,
because this allowed us to validate our results with the actual monthly data, which would not have been
44

possible for yearly data.

For our empirical analysis of credit spread risk we have used daily option-adjusted-spread returns for
thirteen different indices between 2000 and 2014. The spread return data shows significant autocorrelation
and volatility clustering effects causing the square-root-of-time rule to fail. We have started our analysis
by fitting the four-parameter normal inverse Gaussian distribution to the univariate spread return series.
The NIG showed a very good fit to the data that is highly non-normal and it slightly improves over the
more common Students t-distribution. This is a very useful result because the NIG distribution is closed
under convolution which means it can be scaled over time, while the Students t-distribution does not carry
this property. When comparing the NIG fitted to the monthly and daily spread returns we indeed find the
parameters empirically scale in the way we would have expected from theory. In particular, the empirical
scaling of the parameter is strictly in line with theory and is used as a benchmark for the comparison of
various scaling factors.
In this paper two methods for calculating an appropriate scaling factor have been employed. First, a more
general function for the time scaling of volatility has been used that incorporates the effects of autocorrelation.
The scaling function, as shown in equation 2, uses the autocorrelation function of the hypothesized underlying
process of credit spread returns to compute a correction for the scaling factor. Second, a direct relation
between the data and the scaling factor has been used by estimating the Hurst exponent and using S = 22H
(where H would be

1
2

in case of the SRTR).

To approximate the data generating process of credit spread returns we have looked at three model
specifications: AR(1), AR(1) plus GARCH(1,1) and ARFIMA models. Results indicated ARFIMA models
to have a much better fit with the data than the first two simple models. For the thirteen spread series
we have fitted ARFIMA(p,d,q) models with lags p and q between zero and two. Due to optimization
problems for the more complex models we chose the ARFIMA(0,d,0), ARFIMA(1,d,0) and ARFIMA(2,d,0)
models to be used for further analysis and computing scaling factors. For these models, parameter estimates
showed significance and the long memory parameter d was estimated between 0 and

1
2

for most return series.

From d, an estimate for the Hurst exponent H can be obtained by using the relation H = d + 12 . Almost
all series showed significant long memory effects and these effects increased when accounting for short-run
autocorrelations through the AR lags. Plugging the estimated autocorrelation function into the scaling
equation provides us with three scaling factors for each spread serie. The results show factors much higher
than the SRTR, providing strong evidence of long memory in most of the spread return series. A simulation
study of the empirical scaling as compared to our theoretical scaling function showed very good results for
the ARFIMA(0,d,0) model. However, our scaling factor based on the ARFIMA(1,d,0) and ARFIMA(2,d,0)
models deviated quite strongly from the simulated empirical scaling factors, probably due to complexity of
the autocorrelation function which caused inaccurate estimates.
The second method for constructing an appropriate scaling factor is through the estimation of the Hurst
coefficient H. We have evaluated various types of rescaled range analysis as well as the generalized Hurst

45

exponent method. While practically all estimates of H lie above

1
2,

significant effects of long memory were

found for six out of thirteen series. The traditional rescaled range analysis by Hurst gave very little significant
effects, but this can be due to short-term autocorrelation distorting the results. Methods by Lo, Moody and
Wu (MW) and Annis-Lloyd-Peter (ALP) account for these short-term effects and provide more significant
results. When comparing the resulting scaling factors with the empirical scaling factor for the parameter of
the NIG distribution, ALPs and Los scaling factors perform best. All factors computed using this approach
are higher than the traditional square-root-of-time.
To test the actual performance of these factors in scaling the NIG distribution the scaled daily distribution was compared with the fitted monthly distribution. The two-sample KS test checks whether these two
distributions are significantly different. All five Hurst scaling factors and all three ARFIMA scaling factors
outperfom the SRTR. The results show superiority of the Hurst scaling factors over those estimated from
an ARFIMA model. MWs modified rescaled range analysis provides the best scaling factor, with significant
differences in distribution (at the 5% level) for only two out of 13 series. Pictures of the plotted probability
density function of the daily returns distribution scaled by the MW scaling factor compared with the empirical monthly returns distribution confirm these results. Since our data exhibits strong autocorrelation,
the performance of the MW scaling factor could be attributed to the ability to deal with these short-run
correlation effects best.
Last, we backtested the results on historical data by constructing 95% and 99% VaR using the monthly
NIG distributions based on the various scaling factors. The number of violations were found to be much
higher than theoretically expected for all scaling factors. This shows the inherent difficulty with risk modeling
on a lower data frequency and then scaling the results. Nevertheless, all scaling factors strongly outperformed
the SRTR for both 95% and 99% VaR using a static method. The distribution scaled with the MW scaling
factor provided the lowest number of violations for all spread series. In addition to the static method, we
also computed a dynamic VaR based on the past 20 and 50 months of observation. This method performed
slightly worse than the static method, caused by the initial quiet period in the data set leading to relatively low
estimates of VaR for the first few years. Comparing the two window sizes provided inconclusive results, both
performing better and worse for different spread series. All five scaling factors based on Hurst estimation also
outperformed the SRTR in the dynamic set-up, with the MW scaling factor resulting in the lowest number
of violations. A hybrid method, where the scaling factor is held constant but the distribution is re-estimated,
provided similar results as the static and dynamic method.
As we have shown, there is significant improvement in using more sophisticated scaling factors over the
commonly used square-root-of-time in scaling results for risk management purposes. These techniques, in
combination with the normal inverse Gaussian distribution, are very adequate for modeling credit spread
risk under Solvency II. The scaling properties of the NIG distribution are very attractive for risk modeling
purposes in lack of enough data at a certain frequency level. The scaling factors based on ARFIMA models
and Hurst estimation are able to deal with autocorrelation in return data. Since both autocorrelation and

46

lack of yealry data are problems very common in the modeling of credit spread risk and risk management in
general, we strongly recommend the techniques described in this paper.

7.2

Discussion

The aim of this research has been to contribute to the scaling problems that occur in risk management for
the lack of yearly data, but we conduct our analysis on the scaling of daily to monthly spread returns. We do
this so we can properly validate the scaling results with the actual monthly data, which would be practically
impossible on a yearly frequency. The question of course remains whether these techniques would perform
equally well when scaling monthly results to yearly results. The short-run autocorrelations or long memory
characteristics of the data on this level might be different, but all scaling factors account for such effects.
Hence, we believe our methods will also be effective in the scaling of monthly to yearly results and surely
improve over the square-root-of-time.
The methods used in this paper have several points from which errors or inaccuracy might arise. For
the ARFIMA scaling factors, the estimated parameters must be treated with caution, since the optimization
procedure can get stuck in a local minimum. In addition, the estimation of the autocorrelation function is
complex, which could lead to errors. For the Hurst estimation, the optimal choice of number blocks evaluated
in the rescaled range analysis is often debated. For the comparison of the results we have used the estimated
NIG distribution for monthly spread returns, which is based on only 163 data points. This is relatively little,
which could cause an inaccurate fit. It would be interesting to perform a sensitivity analysis on the influence
of all these factors on the results.
Several other interesting topics for future research are also worth mentioning. Further research could look
at other specifications for modeling the underlying process of credit spread returns used for the construction
of scaling factors. It would also be interesting to further investigate the effects of adding GARCH-like models
for volatiltiy in combination with ARFIMA models for example. In this paper, the GARCH effects did not
help the AR(1) specification much, but this could well be purely caused by the poor performance of the
AR specification in modeling spread returns. Although the normal inverse Gaussian showed a good fit with
spread returns, another interesting distribution to explore is the variance-gamma distribution. This class of
distributions is also closed under convolution, which makes it very suitable for risk management applications.
Finally, the techniques as applied to credit spread risk may also be well-suited for other risk factors such as
equity risk and interest rate risk. This would also be an interesting topic for future researcher.

47

References
A. H. Alizadeh and A. Gabrielsen. Dynamics of credit spread moments of european corporate bond indexes.
Journal of Banking & Finance, 37(8):31253144, 2013.
A. Annis and E. Lloyd. The expected value of the adjusted rescaled hurst range of independent normal
summands. Biometrika, 63(1):111116, 1976.
O. Barndorff-Nielsen. Exponentially decreasing distributions for the logarithm of particle size. Proceedings
of the Royal Society of London. A. Mathematical and Physical Sciences, 353(1674):401419, 1977.
O. E. Barndorff-Nielsen. Normal inverse gaussian distributions and stochastic volatility modelling. Scandinavian Journal of statistics, 24(1):113, 1997.
O. E. Barndorff-Nielsen and K. Prause. Apparent scaling. Finance and Stochastics, 5(1):103113, 2001.
J. Barunik and L. Kristoufek. On hurst exponent estimation under heavy-tailed distributions. Physica A:
Statistical Mechanics and its Applications, 389(18):38443855, 2010.
J. Batten, C. Ellis, and W. Hogan. Scaling the volatility of credit spreads: Evidence from australian dollar
eurobonds. International review of financial analysis, 11(3):331344, 2002.
T. Bollerslev. Generalized autoregressive conditional heteroskedasticity. Journal of econometrics, 31(3):
307327, 1986.
W. Breymann and D. L
uthi. ghyp: A package on generalized hyperbolic distributions. 2013.
M. Couillard and M. Davison. A comment on measuring the hurst exponent of financial time series. Physica
A: Statistical Mechanics and its Applications, 348:404418, 2005.
J. Danielsson and J.-P. Zigrand. On time-scaling of risk and the square-root-of-time rule. Journal of Banking
& Finance, 30(10):27012713, 2006.
R. Davidson and J. G. MacKinnon. Econometric theory and methods, volume 5. Oxford University Press
New York, 2004.
F. De Jong and J. Driessen. Liquidity risk premia in corporate bond markets. The Quarterly Journal of
Finance, 2(02), 2012.
L. Della Ratta and G. Urga. Modelling credit spread: a fractional integration approach. Centre for Econometric Analysis Working Paper No. CEA-07-2005, 2005.
T. Di Matteo. Multi-scaling in finance. Quantitative finance, 7(1):2136, 2007.
T. Di Matteo, T. Aste, and M. M. Dacorogna. Scaling behaviors in differently developed markets. Physica
A: Statistical Mechanics and its Applications, 324(1):183188, 2003.
48

F. X. Diebold, A. Hickman, A. Inoue, and T. Schuermann. Converting 1-day volatility to h-day volatility:
scaling by h is worse than you think. University of Pennsylvania, 1997.
K. Domino. The use of the hurst exponent to predict changes in trends on the warsaw stock exchange.
Physica A: Statistical Mechanics and its Applications, 390(1):98109, 2011.
E. Eberlein, J. Kallsen, and J. Kristen. Risk management based on stochastic volatility. Journal of Risk, 5:
1944, 2003.
R. F. Engle. Autoregressive conditional heteroscedasticity with estimates of the variance of united kingdom
inflation. Econometrica: Journal of the Econometric Society, pages 9871007, 1982.
R. F
uss and P. Rindler. Risk decomposition of credit spreads. European Business School Research Paper,
(11-06), 2011.
C. W. Granger and R. Joyeux. An introduction to long-memory time series models and fractional differencing.
Journal of time series analysis, 1(1):1529, 1980.
A. Harri and B. W. Brorsen. The overlapping data problem. Available at SSRN 76460, 1998.
S. L. Heston and S. Nandi. A closed-form garch option valuation model. Review of Financial Studies, 13(3):
585625, 2000.
J.-Z. Huang and M. Huang. How much of the corporate-treasury yield spread is due to credit risk? Review
of Asset Pricing Studies, 2(2):153202, 2012.
H. E. Hurst. {Long-term storage capacity of reservoirs}. Trans. Amer. Soc. Civil Eng., 116:770808, 1951.
K. Jacobs and X. Li. Modeling the dynamics of credit spreads with stochastic volatility. Management Science,
54(6):11761188, 2008.
R. A. Jarrow and S. M. Turnbull. Pricing derivatives on financial securities subject to credit risk. The journal
of finance, 50(1):5385, 1995.
R. A. Jarrow, D. Lando, and S. M. Turnbull. A markov model for the term structure of credit risk spreads.
Review of financial studies, 10(2):481523, 1997.
R. Kiesel, W. Perraudin, and A. Taylor. The structure of credit risk: spread volatility and ratings transitions.
Bank of England, 2001.
A. W. Lo. Long-term memory in stock market prices. Technical report, National Bureau of Economic
Research, 1989.
F. Longstaff and E. Schwartz. Valuing risky debt: A new approach. Journal of Finance, 50(3):789819, 1995.

49

B. B. Mandelbrot and M. S. Taqqu. Robust r/s analysis of long-run serial correlation. Bulletin of the
International Statistical Institute, 48(2):59104, 1979.
B. B. Mandelbrot and J. R. Wallis. Noah, joseph, and operational hydrology. Water resources research, 4
(5):909918, 1968.
B. Martin, S. Rachev, and E. Schwartz. Stable non-Gaussian models for credit risk management. Elsevier/North Holland, 2003.
F. J. Massey Jr. The kolmogorov-smirnov test for goodness of fit. Journal of the American statistical
Association, 46(253):6878, 1951.
J. McCarthy, C. Pantalone, and H. Li. Investigating long memory in yield spreads. The Journal of Fixed
Income, 19(1):7381, 2009.
A. McNeil, R. Frey, and P. Embrechts. Quantitative risk management: Concepts, techniques and tools, 2005.
R. C. Merton. On the pricing of corporate debt: The risk structure of interest rates*. The Journal of Finance,
29(2):449470, 1974.
R. C. Merton. Option pricing when underlying stock returns are discontinuous. Journal of financial economics,
3(1):125144, 1976.
J. Moody, L. Wu, and L. Wu. Improved estimates for the rescaled range and hurst exponents. In Neural
Networks in the Capital Markets. Proceedings of the 3rd International Conference. Citeseer, 1996.
R. Morales, T. Di Matteo, R. Gramatica, and T. Aste. Dynamical generalized hurst exponent as a tool to
monitor unstable periods in financial time series. Physica A: Statistical Mechanics and its Applications,
391(11):31803189, 2012.
R. Neal, D. Rolph, and C. Morris. Interest rates and credit spread dynamics. SSRN eLibrary, 2000.
W. Palma. Long-memory time series: theory and methods, volume 662. John Wiley & Sons, 2007.
M. Pedrosa and R. Roll. Systematic risk in corporate bond credit spreads. The Journal of Fixed Income, 8
(3):726, 1998.
M. Pelagatti and F. Lisi. Variance initialisation in garch estimation. In S. Co. 2009. Sixth Conference.
Complex Data Modeling and Computationally Intensive Statistical Methods for Estimation and Prediction,
page 323. Maggioli Editore, 2009.
E. Peters. Fractal market analysis. John Wiley&Sons, Ine, 1994.
N. Rab and R. Warnung. Scaling portfolio volatility and calculating risk contributions in the presence of
serial cross-correlations. arXiv preprint arXiv:1009.3638, 2010.
50

V. Reisen, B. Abraham, and S. Lopes. Estimation of parameters in arfima processes: A simulation study.
Communications in Statistics-Simulation and Computation, 30(4):787803, 2001.
I. Z. Rejichi and C. Aloui. Hurst exponent behavior and assessment of the mena stock markets efficiency.
Research in International Business and Finance, 26(3):353370, 2012.
I. Solvency. Glossaryceagroupe consultatif brussels, 2007.
F. Sowell. Maximum likelihood estimation of stationary univariate fractionally integrated time series models.
Journal of econometrics, 53(1):165188, 1992.
L. Spadafora, M. Dubrovich, and M. Terraneo. Value-at-risk time scaling for long-term risk estimation. arXiv
preprint arXiv:1408.2462, 2014.

des hautes etudes commerciales (Montreal. Credit spread option valuation

N. Tahani and Q. C. d. g. d. r. Ecole

under GARCH. Ecole

des hautes etudes commerciales, Chaire de gestion des risques, 2000.
M. S. Taqqu and V. Teverovsky. On estimating the intensity of long-range dependence in finite and infinite
variance time series. A practical guide to heavy tails: statistical techniques and applications, 177:218, 1998.
V. Teverovsky, M. S. Taqqu, and W. Willinger. A critical look at los modified r/s statistic. Journal of
statistical Planning and Inference, 80(1):211227, 1999.
J. H. Venter and P. J. de Jongh. Risk estimation using the normal inverse gaussian distribution. Journal of
Risk, 4:124, 2002.
J.-N. Wang, J.-H. Yeh, and N. Y.-P. Cheng. How accurate is the square-root-of-time rule in scaling tail risk:
A global study. Journal of Banking & Finance, 35(5):11581169, 2011.
R. Weron. Estimating long-range dependence: finite sample properties and confidence intervals. Physica A:
Statistical Mechanics and its Applications, 312(1):285299, 2002.
P. Whittle. Estimation and information in stationary time series. Arkiv f
or matematik, 2(5):423434, 1953.
C. Zhou. A jump-diffusion approach to modeling credit risk and valuing defaultable securities. Available at
SSRN 39800, 1997.

51

Simulation results for AR(1) and AR(1) plus GARCH(1,1)

One approach to determining the appropriate factor for scaling the daily credit spread returns distribution
to a monthly distribution is to model the underlying data generating process. The idea is that if a model
can be found that accurately describes the process that drives credit spread changes, Monte Carlo simulation
techniques can be used to compute the scaling factor. In this section we look at two simple models: a pure
AR(1) process and an AR(1) process combined with a GARCH(1,1) volatility process. Both models are
simulated with either a standard normal conditional innovation distribution or a Students t-distribution.
We simulate 1,000,000 paths of 23 daily credit spread returns, where we evaluate days 2 to 23, which sums
up to one simulated month. We discard the first observation, as this is the starting value of the simulation.
A more elaborate discussion of the choice of starting values will folow later.

A.1

AR(1)

Based on the simulated paths we can calculate the scaling factor in various ways. For the simple AR(1)
model, the following methods are used:
P23

i=2

S1 =

where i is the standard deviation of simulated value i. Hence the numerator sums these empirical standard
deviations for the path from time 2 untill 23. In the denominator,
2 is the unconditional sample standard
deviation of estimated AR(1) model.
The second scaling factor has the same numerator, but divides the sum of i by 2 , the standard deviation
at the start of the simulation.
P23

i=2

S2 =

Since we are mostly dealing with positive autocorrelation in the spread return series, we would expect the
sum of the simulated standard deviations to be higher than the square-root-of-time would suggest.
The same two scaling factors are also calculated with an AR(1) model using Students t-innovations
instead of standard normal. The results are depicted in table 15. For the Students t-distributed innovations,
(the degrees of freedom) has been set to 2.5. Including estimation of in the maximum likelihood procedure
yielded values around 2.1, however values so close to 2 gave problems in the simulation, because the variance
goes to infinity as < 2 . Therefore, 2.5 was chosen as it still reflects the heavy tailed distribution of the
error term without distorting the results of the simulation.
If we look at the estimated coefficient for 1 shown in the table, we find that most coefficients are positive.
For the normally disitributed errors, the AR(1) model estimates 1 to be significantly different from zero
for most series, except for the utility sector, A rating and 1-3yrs maturity. Compared with the normal

52

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

1
0.159*
0.076*
0.001
0.133*
0.085*
0.049*
0.009
0.021*
-0.004
-0.126*
0.134*
0.074*
0.113*

Normal
S1
5.534
5.060
4.701
5.376
5.106
4.919
4.729
4.785
4.664
4.192
5.382
5.047
5.266

S2
5.473
5.042
4.693
5.324
5.088
4.917
4.729
4.790
4.670
4.161
5.324
5.034
5.227

Students
1
S1
0.205* 5.712
0.198* 5.679
0.069* 4.995
0.137* 5.299
0.026* 4.760
0.049* 4.832
0.035* 4.836
0.025* 4.654
0.035* 4.852
-0.011 4.630
0.091* 5.107
0.109* 5.681
0.150* 5.355

t
S2
5.890
5.912
5.208
5.441
4.985
5.051
4.805
4.914
4.868
5.037
5.322
4.836
4.829

Table 15: Scaling factors based on Monte Carlo simulation using AR(1) model with normal innovations and Students
t-innovations. * indicates significance at the 1% level for 1

distribution, the model with Students t-distribution provides higher estimates for 1 . Interestingly, the only
series that gives a non-significant estimate is 3-5yrs maturity, which was significantly negative for the model
with normal errors.
In general, the relation between the correlation coefficient 1 and the calculated scaling factors is visible
and as expected. A higher 1 for a certain index results in higher scaling factors S1 and S2 for both normal
and Students t-innovations. Moreover, S2 provides slightly higher results than S1 does, but the differences
are very small. Due to the autocorrelation in most of the series, the standard deviation at the start of the
simulation is slightly smaller than the sample standard deviaton which is an average for the entire path.
Since S2 is the ratio of the sum of simulated standard deviation divided by this standard deviation at the
start, the ratio is indeed expected to be larger than S1 .

A.2

AR(1) plus GARCH(1,1)

A more sophisticated model is one to include a generalized autoregressive conditional heteroskedastic (GARCH)
process to model the volatility of the credit spread returns series. It is probably not realisitic to assume one
estimate for the volatility over the whole sample period, especially because the financial crisis is included (see
figure 2 which clearly shows this volatile period). We have chosen for a simple GARCH(1,1) process that
includes one lag for latent volatility and one lag for squared returns.
Before moving to the various methods of computing simulated scaling factors, let us first examine the
estimated parameters for the GARCH(1,1) process. Table 16 shows the estimated parameters for the model
with normally distributed errors, while table 22 in the appendix provides the results for Students t-distributed
errrors. We will just discuss the main results for the former, but results for the latter are comparable.
When we compare the results for 1 with the AR(1) model, we find that on average the estimated values
are much lower for the AR(1) plus GARCH(1,1) model. In fact, most values for 1 are negative, indicating

53

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

1
0.123*
0.039**
-0.025
0.141*
-0.041**
0.028*
-0.097*
-0.037*
-0.096*
-0.171*
-0.082*
-0.008
0.066*

0
0.038
0.064
0.050
0.046
0.025
0.024
0.014
0.007
0.007
0.007
0.016
0.052
0.043

1
0.156
0.161
0.075
0.134
0.134
0.263
0.184
0.127
0.068
0.148
0.200
0.173
0.095

1
0.844
0.839
0.925
0.866
0.866
0.737
0.816
0.873
0.932
0.852
0.800
0.827
0.905

VL
189588
320675
251536
228434
124348
117978
70450
34777
33976
35155
77953
260661
212833

Table 16: Estimated parameters for AR(1)-GARCH(1,1) with normally distributed errors. ** indicates significance
at the 5% level and * indicates significance at the 1% level. All parameters for 0 , 1 and 1 are significant at the
1% level

mean-reversion of credit spread returns rather than momentum. The indices for the corporate and industrial
sector - and to a lesser extend the financial sector - are still showing significant positive first order correlation.
When looking at the estimated GARCH parameters, the first thing you notice is that 1 and 1 seem to
sum up to one for all indices. This is not actually the case, but the sum does lie very close to one. Consequently, the long run variance calculated as VL =

0
11 1

blows up drastically, because the denominator

becomes much smaller than 0 . The same thing happens for the model with Students t-errors, as shown in
table 22 in the appendix. Consequently, we can conclude that that the variance in fact follows an Integrated
GARCH (IGARCH) model.
Now that we have seen the AR(1)-GARCH(1,1) fitted to our data, we can move to the Monte Carlo
simulation used to calculate the scaling factors. A very important aspect of simulating the GARCH process
is chosing starting values. Although not much attention has been paid to this initialisation in the literature
it can have significant effect on the parameter estimates. As Davidson and MacKinnon (2004) argue, finding
suitable starting values for GARCH models is much harder than for ARMA models, because we cannot
simply draw them from a stationary distribution. One solution to this problems is to start the simulation
for a large negative t and then discard all non-positive values. It is natural to set the initial values of t2
to the unconditial expecation of u2t . Arguably this method eliminates the effect of the starting values and
approximates drawing from the stationary distribution. Additional methods of initialisation are discussed by
Pelagatti and Lisi (2009).
The following methods for calculating scaling factors have been employed. The first two scaling factors are
initialised by unconditional expecations of the error term and spread return process, both zero respectively.
For the starting value of u2t the last estimated conditional variance of the spread return series is taken. S3

54

and S4 then become:

S3 =
S4 =

P23

2
P23

i=2

k=2

where i is the sample standard deviation of the simulated process at time i. Hence S3 is the ratio of the sum
of sample standard deviations for simulated value 2 to 23 divided by the standard deviation for simulated
value 2. S4 is calculated in the same way, only it starts the simulation at point -250 and only uses the values
from 2 to 23, which is the same as saying k = i + 250. This is the method mentioned by Davidson and
McKinnon, where the number 250 is chosen by evaluating the plots of simulated conditional variances. Even
if a huge starting value for u2t is chosen, the simulated variances becomes relatively stable after observation
200.
The second initialisation that is tested is the same as for S3 and S4 , but instead of taking the last
estimated conditional variance for the spread return series, the average conditional variance over the entire
sample is taken as starting value. Instead of giving more weigth to the situation today, this method uses the
historical volatility over the last 14 years as starting value. Since the situation in 2014 is relatively calm,
one can expect the average conditional variance to be higher than the last value, mainly due to the financial
crisis. Other than this starting value S5 and S6 are calculated in the same way as S3 and S4 . The last initial
value for u2t is set at the unconditonal variance (shown in table 16). Because these value are extremely large,
the initialisation period of 250 days is definitely needed, so we only calculate the scaling factor starting on
time k = i + 250, which results in S7 .
Another approach is to calculate the ratio as the square root of the sum of 22 conditional variances divided
by the first conditonal variance. As such,
sP

23
i=2
22

S8 =

i2

sP

23
2
k=2 k
2
k+1

S9 =

where i2 is the conditional variance for time i, simulated from the GARCH(1,1) process. In similar fashion,
S10 and S11 are calculated in the same way but using the mean conditional variance instead of the last
condtional variance as starting value. S12 is calculated with the unconditional variance as starting value, but
letting the simulation run for 250 observations before computing the scaling factor like before.
The results shown in table 17 provide several interesting insights. First, it is expected that the scaling
factors are slightly lower than for the AR(1) model, since the estimated coefficents for 1 are lower. However,
it is not immediately evident that this is the case. This could be the cause of the persistence in the volatility
that is modeled by the GARCH process, especially since the 1 coefficients are all very high.

55

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

S3
6.199
6.477
4.722
6.723
5.099
5.525
4.656
4.673
4.399
4.883
5.382
6.279
5.269

S4
5.279
5.238
4.801
5.620
4.632
5.209
5.016
4.616
4.456
4.144
4.651
2.932
5.178

S5
5.450
4.982
4.794
5.631
4.579
5.013
4.365
4.552
4.314
4.044
4.367
4.738
5.030

S6
5.415
5.101
4.745
5.540
4.815
4.377
5.186
4.820
4.281
5.227
3.763
4.071
5.174

S7
4.916
4.860
4.717
5.659
4.413
8.876
7.202
4.621
4.376
4.122
6.591
4.968
4.918

S8
5.424
4.748
4.925
5.529
4.721
2.938
4.454
4.586
4.796
4.552
3.685
4.594
4.531

S9
5.520
6.209
4.837
5.835
5.305
5.292
5.056
4.828
4.818
5.674
5.754
6.239
4.919

S10
3.381
4.192
4.697
4.836
4.421
5.521
4.008
4.554
4.878
7.012
6.100
6.021
4.607

S11
4.842
4.811
4.897
4.910
4.793
4.819
4.754
4.717
4.721
4.784
4.724
4.793
4.722

S12
4.708
4.638
4.908
4.430
4.750
4.933
5.845
5.152
4.872
4.411
3.963
5.121
5.253

Table 17: Scaling factors based on Monte Carlo simulation using AR(1)+GARCH(1,1) model with normal innovations
and various intialisation procedures. N=100,000

If we take a closer look at the scaling factors based on the sample standard deviations, it is evident that S4
and S6 are almost identical. In fact, it can be expected that as the number of MC simulation increases they
converge to the same value. Although their initialisations procedures are different, this effect is eliminated
after the starting period of 250 observations. For S7 , which starts with the unconditional variance, this effect
is more visible and scaling factors are especially high for AA- and A-rated spread indices.
Let us compare the results of S3 and S5 , which either have the starting value of the last estimated
conditional variance of the spread return series or the mean conditional variance of the spread series. The
results show that indeed the former produces higher scaling factors than the lattter, because the there is no
initialisation period. This means that the scaling factor S3 divides by the second value of the simulation,
which is still relatively close to the last estimated conditional variance of the spread return serie and will be
much smaller than the mean conditional variance of the spread serie. As a result S3 divides by a smaller
number than S5 and produces higher scaling factors. For S10 , which uses the mean contional variance of the
spread return serie as starting value of the simulation, we find that the result is strongly influences by this
same starting value. Interestingly, when we first initialise the simulation for 250 days, the resulting scaling
factor S11 becomes almost identical for all indices and seems to approximate the square root of time rule
factor.
Now we turn to the last model, namely the AR(1) plus GARCH(1,1) with Students t-distributed innovations. As mentioned, the etimated parameters including the degrees of freedom of the t-distribution are
shown in table 22 in the appendix. The average estimated value for lies around 4 indicating a significant
deviation from normality. If we compare the results with the model that simulates innovations from the
normal distribution, the scaling factors S3 and S5 are very comparable while S4 and S6 . This is the result
of the initialisation period of 250 days for the latter scaling factors, which gives the simulation much more
time to incorporate higher innovations coming from the more heavy tailed t-distribution.
Some strange results come from the scaling factors that start with the unconditional variance, S7 and S12 ,
56

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

S3
6.144
6.179
4.848
6.805
4.744
4.790
4.701
4.798
4.832
5.522
5.199
6.040
5.790

S4
4.140
4.706
5.383
5.876
4.480
2.243
4.412
5.067
4.677
4.026
4.598
5.150
6.204

S5
5.586
4.971
5.844
5.672
5.372
4.790
4.372
4.743
4.516
4.242
4.467
4.962
5.338

S6
6.250
5.907
5.424
4.796
4.226
4.051
2.470
8.848
4.831
4.634
5.022
4.979
6.373

S7
4.664
5.322
7.876
5.321
3.933
3.505
8.186
8.718
1.535
2.174
6.294
3.237
5.166

S8
3.461
4.282
3.964
3.187
5.318
4.209
6.070
4.038
2.471
3.595
2.586
3.763
3.024

S9
4.750
4.717
4.517
5.538
4.957
4.288
4.784
4.678
4.010
5.083
4.753
4.816
4.803

S10
3.721
2.827
3.455
3.103
4.116
3.813
3.963
5.385
3.327
2.833
3.405
4.093
5.022

S11
4.768
6.984
4.723
4.610
4.730
4.608
4.387
4.478
4.828
4.590
4.655
4.414
4.021

S12
4.018
4.840
3.354
5.184
3.766
3.186
6.612
4.746
3.243
3.206
5.319
3.330
4.100

Table 18: Scaling factors based on Monte Carlo simulation using AR(1)+GARCH(1,1) model with Students tinnovations and various intialisation procedures. N=100000

even though it includes the initialisation period of 250 days. For example, for 1-3yrs and 3-5yrs maturity S7 is
extremely small, while it is rather high for A and BBB rated indices. S12 seems to underestimate the scaling
factor for almost all indices. In general we can conclude that neither the AR(1) nor the AR(1)+IGARCH(1,1)
process correctly models spread returns such that a scaling factor can properly be computed.

57

Additional figures and tables

Figure 11: Overview of sub-classes of generalized hyperbolic distribution

Figure 12: Autocorrelation function plots for credit spread changes up to 22 lags, categorized by rating. Top left
panel: AAA. Top right panel: AA. Bottom left panel: A. Bottom right panel: BBB.

58

Figure 13: Autocorrelation function plots for credit spread changes up to 22 lags, categorized by maturity. Top left
panel: 1-3 years. Top right panel: 3-5 years. Middle left panel: 5-7 years. Middle right panel: 7-10 years. Bottom
left panel: 10+ years.

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22

Corp.

Fin.

Indu.

Uti.

AAA

AA

BBB

1-3yrs

3-5yrs

5-7yrs

7-10yrs

10+yrs

0.16
0.19
0.12
0.14
0.17
0.13
0.15
0.14
0.09
0.14
0.11
0.13
0.10
0.05
0.11
0.06
0.08
-0.00
0.07
0.11
0.04
0.07

0.08
0.16
0.10
0.12
0.12
0.10
0.12
0.12
0.07
0.10
0.10
0.09
0.08
0.02
0.09
0.02
0.05
-0.04
0.05
0.08
0.02
0.04

0.00
0.12
0.01
0.07
0.07
0.04
0.05
0.08
0.02
0.07
0.03
0.09
0.04
0.01
0.06
0.06
0.05
0.01
0.04
0.08
0.02
0.00

0.13
0.14
0.14
0.14
0.15
0.11
0.13
0.15
0.10
0.14
0.09
0.13
0.09
0.05
0.10
0.07
0.08
0.01
0.06
0.09
0.04
0.05

0.09
-0.04
-0.07
-0.01
0.09
0.08
-0.00
-0.04
0.00
0.07
0.05
0.05
0.01
0.02
0.04
0.04
0.07
-0.05
0.04
0.00
0.03
-0.01

0.05
-0.05
-0.07
-0.00
0.06
0.06
0.02
-0.01
-0.03
0.04
0.02
0.08
0.04
-0.02
0.04
0.04
0.04
-0.06
0.03
0.00
0.02
-0.00

0.01
-0.03
-0.08
0.01
0.07
0.04
-0.00
-0.02
-0.02
0.05
0.02
0.06
0.04
-0.01
0.00
0.05
0.06
-0.04
0.01
0.00
0.03
-0.03

0.02
-0.04
-0.07
0.00
0.03
0.03
0.00
-0.05
-0.03
0.03
-0.01
0.04
0.04
-0.01
-0.01
0.04
0.05
-0.06
-0.01
-0.01
0.04
-0.02

-0.00
-0.06
-0.06
0.02
0.01
0.03
-0.00
-0.05
-0.03
-0.01
-0.02
0.02
-0.00
-0.02
-0.01
0.01
0.05
-0.06
0.03
-0.02
0.04
-0.03

-0.13
-0.05
-0.06
0.02
0.08
-0.01
0.00
0.01
-0.02
0.02
-0.02
0.07
0.00
-0.05
0.03
0.04
0.10
-0.08
0.01
0.01
0.01
-0.01

0.13
-0.05
-0.07
-0.00
0.05
0.03
-0.02
-0.07
-0.01
0.01
0.02
0.06
0.04
0.03
0.04
0.04
0.01
-0.07
-0.03
-0.05
0.03
0.01

0.07
0.04
-0.01
0.03
0.04
0.03
0.01
0.05
0.04
0.14
0.11
0.07
0.02
-0.03
0.04
0.06
0.12
-0.02
0.01
0.04
0.02
-0.03

0.11
-0.02
-0.03
-0.03
0.03
0.14
0.05
-0.04
-0.03
0.04
-0.04
0.05
0.06
0.03
0.04
0.01
0.02
0.00
0.06
0.03
0.03
-0.00

Table 19: Sample autocorrelation coefficients of lags 1-22 for time series of daily spread returns. i is the sample
autocorrelation coefficient at lag i

59

xt
xt1
xt2
xt3
xt4
xt5
xt6
xt7
xt8
xt9
xt10
xt11

xt
1.00
0.16
0.19
0.12
0.14
0.17
0.13
0.15
0.14
0.09
0.14
0.11

xt1
0.16
1.00
0.16
0.19
0.12
0.14
0.17
0.13
0.15
0.14
0.09
0.14

xt2
0.19
0.16
1.00
0.16
0.19
0.12
0.14
0.17
0.13
0.15
0.14
0.09

xt3
0.12
0.19
0.16
1.00
0.16
0.19
0.12
0.14
0.17
0.13
0.15
0.14

xt4
0.14
0.12
0.19
0.16
1.00
0.16
0.19
0.12
0.14
0.17
0.13
0.15

xt5
0.17
0.14
0.12
0.19
0.16
1.00
0.16
0.19
0.12
0.14
0.17
0.13

xt6
0.13
0.17
0.14
0.12
0.19
0.16
1.00
0.16
0.19
0.12
0.14
0.17

xt7
0.15
0.13
0.17
0.14
0.12
0.19
0.16
1.00
0.16
0.19
0.12
0.14

xt8
0.14
0.15
0.13
0.17
0.14
0.12
0.19
0.16
1.00
0.16
0.19
0.12

xt9
0.09
0.14
0.15
0.13
0.17
0.14
0.12
0.19
0.16
1.00
0.16
0.19

xt10
0.14
0.09
0.14
0.15
0.13
0.17
0.14
0.12
0.19
0.16
1.00
0.16

xt11
0.11
0.14
0.09
0.14
0.15
0.13
0.17
0.14
0.12
0.19
0.16
1.00

Table 20: Sample autocorrelation matrix for corporate index (Corp.). Lags between 1 and 11 are depicted. xt is a
corporate index daily credit spread return at time t

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

0.010
0.004
0.018
0.018
0.007
0.014
0.016
0.014
0.016
0.021
0.004
0.006
0.011

(0.041)
(0.020)
(0.048)
(0.057)
(0.017)
(0.029)
(0.031)
(0.024)
(0.022)
(0.019)
(0.018)
(0.027)
(0.075)

0.002 (0.745
0.001 (0.589)
0.004 (0.569)
0.006 (0.749)
0.001 (0.236)
0.003 (0.318)
0.003 (0.304)
0.003 (0.254)
0.003 (0.181)
0.002 (0.103)
0.000 (0.211)
0.001 (0.641)
0.002 (1.541)

-1.148 (5.965)
-0.749 (14.865)
-0.824 (3.537)
-2.114 (3.731)
-0.229 (8.557)
-0.403 (4.278)
-0.313 (3.808)
-0.123 (4.098)
-0.017 (3.529)
-0.071 (2.754)
-0.080 (27.444)
-0.648 (9.522)
-3.126 (6.244)

6.780 (2.186)
5.948 (3.173)
5.082 (1.480)
6.560 (1.787)
2.348 (1.483)
3.139 (1.260)
3.069 (1.175)
2.428 (1.078)
1.781 (0.862)
1.047 (0.568)
2.137 (1.952)
6.141 (2.570)
13.886 (3.316)

Table 21: Estimated parameters of NIG distribution forp

all 13 monthly spread return series based on maximum
likelihood procedure. Standard error estimates based on diag(H1 ) are shown in parentheses (H is the Hessian
matrix)

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

1
0.134*
0.071**
0.039
0.155*
-0.047**
-0.019
-0.057**
0.017
-0.053**
-0.135*
-0.047**
0.087*
0.138*

0
0.027
0.031
0.027
0.038
0.016
0.010
0.008
0.006
0.008
0.006
0.008
0.020
0.061

1
0.175
0.225
0.158
0.160
0.190
0.241
0.216
0.223
0.294
0.271
0.231
0.237
0.178

1
0.825
0.775
0.842
0.840
0.810
0.759
0.784
0.777
0.706
0.729
0.769
0.763
0.822

3.746
3.812
3.258
3.540
3.943
4.026
4.142
4.024
4.142
3.894
4.063
3.797
3.633

VL
135533
156871
135496
191193
77940
51337
39860
32404
40664
31065
42069
100258
306078

Table 22: Estimated parameters for AR(1)-GARCH(1,1) with Students t-distributed errors. ** indicates significance
at the 5% level and * indicates significance at the 1% level. All parameters for 0 , 1 and 1 are significant at the
1% level

60

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

(0,0)
2.811
3.579
2.681
2.573
2.830
2.774
2.762
2.824
2.706
1.747
3.512
3.683
4.705

(0,1)
2.798
3.558
2.668
2.559
2.827
3.000
3.016
2.823
2.705
1.755
3.526
3.701
4.701

(0,2)
2.798
3.558
2.668
2.555
2.826
2.930
2.888
2.823
2.705
1.749
3.648
3.834
4.701

(1,0)
2.799
3.559
2.667
2.563
2.828
2.787
2.775
2.824
2.705
1.756
3.512
3.683
4.702

(2,0)
2.799
3.559
2.667
2.559
2.825
2.784
2.774
2.823
2.705
1.753
3.509
3.696
4.700

(1,1)
2.793
3.554
2.666
2.550
2.821
2.778
2.768
2.820
2.705
3.511
4.698

(1,2)
2.793
3.554
2.666
2.550
2.818
2.776
2.820
2.704
1.746
3.872
4.695

(2,1)
2.793
3.554
2.665
2.549
2.816
2.785
2.819
2.704
1.746
3.509
3.814
4.694

(2,2)
2.793
3.554
2.662
2.550
2.816
2.820
2.718
1.747
3.508
3.702
4.694

Table 23: AIC values for nine ARFIMA(p,d,q) specifications with p and q between 0 and 2. Column headers represent
the p and q values of the ARMA part. When no value is shown, the EML estimation algorithm did not converge.
Bold indicates the lowest AIC value for a particular serie

Figure 14: Distribution of scaling factors from Monte Carlo simulation for ARFIMA(1,d,0) process. 1,100,000 daily
spread returns were simulated 1000 times to construct 1000 scaling factors using the relation between the monthly
and daily sample variance. The red line shows the theoretical scaling factor as computed from equation 2.The green
line shows a scaling factor computed as 22H where H = d + 0.5.

61

Figure 15: Distribution of scaling factors from Monte Carlo simulation for ARFIMA(2,d,0) process. 1,100,000 daily
spread returns were simulated 1000 times to construct 1000 scaling factors using the relation between the monthly
and daily sample variance. The red line shows the theoretical scaling factor as computed from equation 2. The green
line shows a scaling factor computed as 22H where H = d + 0.5.

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Hurst
23
24
19
25
16
20
20
18
18
13
12
19
22

Lo
23
24
17
25
14
19
20
15
16
13
12
19
21

MW
23
23
17
23
14
19
20
14
15
13
12
16
21

ALP
23
24
18
27
14
20
20
18
16
13
12
20
24

GHE
23
24
24
25
16
23
23
18
18
18
14
22
28

ARF00
23
25
27
27
16
22
23
18
18
18
12
22
28

ARF10
23
24
24
27
16
22
23
18
18
18
14
22
28

ARF20
23
24
24
25
16
22
23
18
18
18
14
22
28

SRTR
29
29
28
29
17
23
23
18
18
14
15
24
30

Table 24: Number of violations of 95% VaR based on Monte Carlo simulation from scaled monthly NIG distribution,
using five different scaling factors. A static method is used based on the entire sample

62

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Hurst
24
23
23
23
19
20
17
13
13
12
16
19
30

20 months
Lo MW ALP
21 21
26
19 18
20
20 20
20
23 22
26
15 14
17
18 17
19
16 16
17
13 13
17
12 11
16
12 12
13
15 15
19
19 19
22
28 26
25

GHE
26
30
29
27
23
24
27
20
24
22
25
24
31

Hurst
24
26
23
19
19
22
20
15
15
15
18
20
23

50 months
Lo MW ALP
23 22
22
23 23
24
19 19
21
18 18
19
18 18
18
22 22
21
20 19
18
12 12
14
15 14
15
15 14
14
17 17
18
20 19
19
23 23
22

GHE
25
28
23
19
23
23
24
21
20
18
22
22
24

Table 25: Number of violations of 95% VaR based on Monte Carlo simulation from scaled monthly NIG distribution,
using five different scaling factors. A dynamic (conditional) method is used with a 20 months and 50 months window
for estimation

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Hurst
26
23
23
26
16
19
17
13
15
15
15
22
27

Lo
24
20
23
21
16
18
16
13
12
14
14
20
27

95% VaR
MW ALP
23
26
17
22
22
23
20
28
15
15
17
18
15
16
13
13
12
12
12
14
13
15
19
23
24
30

GHE
26
20
25
26
17
24
19
14
15
18
17
25
30

SRTR
39
30
28
38
17
24
18
13
15
15
17
25
31

Hurst
12
10
14
18
9
10
9
8
1
7
12
14
11

Lo
11
9
14
18
9
9
8
7
1
7
10
12
11

99% VaR
MW ALP
11
12
9
10
12
14
16
18
9
9
9
9
8
8
6
9
0
1
6
7
10
11
11
15
11
13

GHE
11
9
16
18
10
10
10
11
5
8
12
16
17

SRTR
18
12
19
20
10
10
10
9
2
7
12
17
20

Table 26: Number of violations of 95% VaR based on Monte Carlo simulation from scaled monthly NIG distribution,
using five different scaling factors. A dynamic (conditional) method is used with a 20 months window. The scaling
factor is not re-estimated every month

63

Corp.
Fin.
Uti.
Indu.
AAA
AA
A
BBB
1-3yrs
3-5yrs
5-7yrs
7-10yrs
10+yrs

Hurst
25
24
21
20
20
22
21
13
15
14
19
21
23

Lo
23
22
19
19
19
21
19
11
15
14
18
19
23

95% VaR
MW ALP
20
25
19
23
18
20
18
20
19
18
20
21
18
20
11
14
13
15
14
14
16
18
19
21
22
24

GHE
23
23
22
20
20
22
23
18
17
19
19
21
24

SRTR
29
30
26
31
22
22
22
16
16
16
19
24
25

Hurst
10
9
15
14
11
13
13
10
7
8
12
14
14

Lo
10
8
15
13
11
12
11
9
4
6
12
14
12

99% VaR
MW ALP
10
10
8
8
14
15
13
14
11
11
12
13
11
12
8
11
4
5
6
6
12
12
14
14
12
19

GHE
10
8
15
14
12
15
13
11
9
12
12
14
19

SRTR
15
14
16
16
13
15
13
11
9
9
12
15
20

Table 27: Number of violations of 95% and 99% VaR based on Monte Carlo simulation from scaled monthly NIG
distribution using five different scaling factors. A dynamic (conditional) method is used with a 20 months window.
The scaling factor is not re-estimated every month

64