Can Credit Default Swaps Predict Financial Crises: An Empirical Test on Emerging Markets

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Can Credit Default Swaps Predict Financial Crises: An Empirical Test on Emerging Markets

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Neziri, Hekuran

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Hekuran Neziri

Abstract

We explore the informational value of credit default swaps and the extent to which they may be linked to financial crises. After developing a theoretical framework to model the relationship between credit default swap market and equity and currency markets, we apply an empirical study which uses logistic regressions and a panel data sample of emerging markets to assess the ability of these financial instruments to predict crises. Regarding them as reflections of future expectations of investors on the outcomes of currency and equity markets, we find credit default swaps to be a significant indicator explaining the periods proceeding financial crises, at least in equity markets. The inclusion of credit default swaps as a factor in models that predict crises and their ability to improve predictions in equity market is a major contribution of this study to the existing literature.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13096.

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Date of creation: 10 Dec 2008
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Handle: RePEc:pra:mprapa:13096

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F3 - International Economics - - International Finance

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-02-07 (All new papers)
NEP-RMG-2009-02-07 (Risk Management)

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Kumar, Mohan & Moorthy, Uma & Perraudin, William, 2003. "Predicting emerging market currency crashes," Journal of Empirical Finance, Elsevier, vol. 10(4), pages 427-454, September. [Downloadable!] (restricted)
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Other versions:
- Eugene White & Frederic Mishkin, 2002. "U.S.Stock Market Crashes and Their Aftermath: Implications for Monetary Policy," Departmental Working Papers 200208, Rutgers University, Department of Economics. [Downloadable!]
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Other versions:
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- Graciela L. Kaminsky & Carmen M. Reinhart, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June. [Downloadable!] (restricted)
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Yoon Sook Kim & Jorge A. Chan-Lau, 2004. "Equity Prices, Credit Default Swaps, and Bond Spreads in Emerging Markets," IMF Working Papers 04/27, International Monetary Fund. [Downloadable!]

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