Credit Default Swaps and Equity Prices: The Itraxx CDS Index Market
AbstractIn this paper we provide some early evidence of a link between the iTraxx credit default swap (CDS) index market and the stock market. To our knowledge this is the first paper studying this relationship. Knowledge about the link between stock prices, stock return volatilities and CDS spreads is important not only for risk managers using credit default swaps for hedging purposes, but also to anyone trying to profit from arbitrage possibilities in the CDS market. For a sample of European sectoral iTraxx CDS indexes, a correlation study reveals a tendency for iTraxx CDS spreads to narrow when stock prices rise and vice versa. Furthermore, there is some evidence of firm-specific information being embedded into stock prices before it is embedded into CDS spreads. Stock price volatility is also found to be significantly correlated with CDS spreads and the spreads are found to increase (decrease) with increasing (decreasing) stock price volatilities. Finally, we find significant positive autocorrelation in the iTraxx market.
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Bibliographic InfoPaper provided by Lund University, Department of Economics in its series Working Papers with number 2005:24.
Length: 14 pages
Date of creation: 11 Mar 2005
Date of revision: 15 May 2005
Publication status: Published in Credit Risk - Models, Derivatives, and Management, Wagner, Niklas (eds.), 2008, pages 69-83, Chapman & Hall.
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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/
More information through EDIRC
credit default swap index; stock market index; stock return volatility;
Find related papers by JEL classification:
- C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-03-20 (All new papers)
- NEP-FIN-2005-03-20 (Finance)
- NEP-FMK-2005-03-20 (Financial Markets)
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