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The fast and the furious--Stock returns and CDS of financial institutions under stress

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  • Trutwein, Patrick
  • Schiereck, Dirk

Abstract

This paper examines the link between equity and credit markets for major financial institutions during times of heightened stress and increased default risk. We focus on sizeable US firms, which either failed or required substantial government support during 2008. Our examination of daily lead-lag relationships of 5-year credit default swaps, equity prices, and implied option volatility shows that equity and credit markets become more integrated during times of heightened stress and that fast equity price changes lead furious CDS spread changes. We confirm a strong positive link between changes in CDS spreads and in option implied volatility and find that adjustments take place simultaneously. Our results point at a regime dependent relationship between equity and credit markets and have practical relevance for capital markets regulation, e.g. the ban on short selling of financial stocks.

Suggested Citation

  • Trutwein, Patrick & Schiereck, Dirk, 2011. "The fast and the furious--Stock returns and CDS of financial institutions under stress," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(2), pages 157-175, April.
  • Handle: RePEc:eee:intfin:v:21:y:2011:i:2:p:157-175
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    References listed on IDEAS

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    1. Edith S. Hotchkiss & Tavy Ronen, 2002. "The Informational Efficiency of the Corporate Bond Market: An Intraday Analysis," Review of Financial Studies, Society for Financial Studies, vol. 15(5), pages 1325-1354.
    2. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
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    7. Jorion, Philippe & Zhang, Gaiyan, 2007. "Good and bad credit contagion: Evidence from credit default swaps," Journal of Financial Economics, Elsevier, vol. 84(3), pages 860-883, June.
    8. Christoph Benkert, 2004. "Explaining credit default swap premia," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(1), pages 71-92, January.
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    Cited by:

    1. Narayan, Paresh Kumar, 2015. "An analysis of sectoral equity and CDS spreads," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 34(C), pages 80-93.
    2. Annaert, Jan & De Ceuster, Marc & Van Roy, Patrick & Vespro, Cristina, 2013. "What determines Euro area bank CDS spreads?," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 444-461.
    3. Kiesel, Florian & Kolaric, Sascha & Schiereck, Dirk, 2016. "Market integration and efficiency of CDS and equity markets," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 209-229.
    4. Veronika Kajurova & Jana Hvozdenska, 2016. "Linkages between CDS, bond and stock markets: Evidence from Europe," MENDELU Working Papers in Business and Economics 2016-63, Mendel University in Brno, Faculty of Business and Economics.
    5. repec:eee:intfin:v:52:y:2018:i:c:p:114-133 is not listed on IDEAS
    6. Kiesel, Florian, 2016. "The effect of credit and rating events on credit default swap and equity markets," Publications of Darmstadt Technical University, Institute for Business Studies (BWL) 81265, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute for Business Studies (BWL).
    7. Kizys, Renatas & Paltalidis, Nikos & Vergos, Konstantinos, 2016. "The quest for banking stability in the euro area: The role of government interventions," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 40(C), pages 111-133.

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