The Relationship Between Credit Default Swap and Cost of Equity Capital

Abstract

We want to assess the relationship between the equity and the debt cost of capital. Using a very simple dividend discount model we compute the implied discount rate and we compare it with the corresponding premium on the corporate credit default swap using a cointegration approach. We demonstrated the existence of a cointegrating relationship between those two variables and we found weak evidence of Granger causality from CDS premium to the discount factor. Our findings are also robust to the choice of different parameter assumptions and model specification.