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Relation between Credit Default Swap Spreads and Stock Prices: A Non-linear Perspective

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  • Miroslav Mateev

    (American University in the Emirates)

  • Elena Marinova

    (EM Capital Consult Ltd.)

Abstract

In this study, we investigate the relation between credit risk, as implied in the credit default swaps (CDS), and market prices of Markit iTraxx Europe index companies. To test the hypothesis of co-integration between CDS and stock prices, we apply linear and non-linear models that allow for structural breaks. Using Johansen trace test of cointegration for a set of 109 pairs of CDS and stock prices of the companies included in the index, over the period of January 2012 to January 2016, we find that at the 10% level of significance, the null hypothesis of no cointegration is rejected for 26 pairs. We extend our analysis by allowing for a one-time structural break with unknown timing. Using alternative cointegration tests, we find that CDS and stock prices are cointegrated. More specifically, there are 47 companies in our sample for which CDS spreads and stock prices are cointegrated at the 10% level of significance. The existence of a long-run relation between CDS and stock prices of the European investment-grade companies is evidence for a possible transmission of shocks between the two segments of the financial market – the credit market (via CDS) and the stock market.

Suggested Citation

  • Miroslav Mateev & Elena Marinova, 2019. "Relation between Credit Default Swap Spreads and Stock Prices: A Non-linear Perspective," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 43(1), pages 1-26, January.
    • Handle: RePEc:spr:jecfin:v:43:y:2019:i:1:d:10.1007_s12197-017-9423-9
    DOI: 10.1007/s12197-017-9423-9
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    More about this item

    Keywords

    Credit default swap; iTraxx index; Cointegration; Structural breaks; Threshold;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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