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Credit derivatives: instruments of hedging and factors of instability. The example of ?Credit Default Swaps? on French reference entities

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  • Nathalie Rey

    (CEPN)

Abstract

Through a long-period analysis of the inter-temporal relations between the French markets for credit default swaps (CDS), shares and bonds between 2001 and 2008, this article shows how a financial innovation like CDS could heighten financial instability. After describing the operating principles of credit derivatives in general and CDS in particular, we construct two difference VAR models on the series: the share return rates, the variation in bond spreads and the variation in CDS spreads for thirteen French companies, with the aim of bringing to light the relations between these three markets. According to these models, there is indeed an interdependence between the French share, CDS and bond markets, with a strong influence of the share market on the other two. This interdependence increases during periods of tension on the markets (2001-2002, and since the summer of 2007).

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Paper provided by arXiv.org in its series Papers with number 0911.4039.

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Date of creation: Nov 2009
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Handle: RePEc:arx:papers:0911.4039

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  1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
  2. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
  3. Jarrow, Robert A. & Turnbull, Stuart M., 2000. "The intersection of market and credit risk," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 271-299, January.
  4. Skinner, Frank S. & Townend, Timothy G., 2002. "An empirical analysis of credit default swaps," International Review of Financial Analysis, Elsevier, vol. 11(3), pages 297-309.
  5. Batten, Jonathan & Hogan, Warren, 2002. "A perspective on credit derivatives," International Review of Financial Analysis, Elsevier, vol. 11(3), pages 251-278.
  6. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
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