Credit-Implied Volatility

We define and construct a credit-implied volatility (CIV) surface from the firm-by-maturity panel of credit default swap (CDS) spreads. We use this framework to organize the behavior of corporate credit markets into three stylized facts. First, CIV exhibits a steep moneyness smirk. Second, the joint dynamics of credit spreads on all firms are captured by three interpretable factors in the CIV surface. Third, the cross-section of CDS risk premia is fully explained by exposures to CIV surface shocks. We propose a structural model for joint asset behavior of all firms that is characterized by stochastic volatility and time-varying downside tail risk in aggregate asset growth.