Credit risk management in Greater China

In this paper the focus is on market‐wide credit protection. More exactly, the newly introduced iTraxx Greater China credit default swap (CDS) index is examined, and to what degree this index can be used to protect against market‐wide credit risk in the Greater China area is assessed. Although the iTraxx Greater China CDS index is found to be significantly correlated with both the value and volatility of an equally weighted stock portfolio of the names in the CDS index itself, it is found to move more or less independently from some of the most widely used stock indexes in the Greater China region. Not surprisingly, considering the geographical distribution of the constituents in the iTraxx Greater China index, the major stock indexes covering mainland China are found to be particularly uncorrelated with the CDS index. Based on well‐known theoretical arguments as well as extensive empirical evidence in the literature, it is argued that this makes it difficult to manage credit risk in mainland China using the iTraxx Greater China CDS index, at least until more mainland China names have been included in the CDS index. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:582–597, 2008