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The Interactions Between the Credit Default Swap and the Bond Markets in Financial Turmoil

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  • Virginie Coudert
  • Mathieu Gex

Abstract

We analyse the links between credit default swap (CDS) and bond spreads and try to determine which one is the leading market in the price discovery process. To do that, we construct a sample of CDS premia and bonds spreads on a generic 5-year bond, for 17 financials and 18 sovereigns. First, we run VECM estimations, showing that the CDS market has a lead over the bond market over the whole sample. A decomposition of the sample shows that this result holds for financials as well as for the high-yield emerging sovereigns. However, the bond market still drives the CDS market for the sovereigns in the core of the euro area. Second, we check for non-linearities in the adjustment process during the current crisis. Results show that the CDS market's lead has been amplified by the crisis for financial institutions.

Suggested Citation

  • Virginie Coudert & Mathieu Gex, 2011. "The Interactions Between the Credit Default Swap and the Bond Markets in Financial Turmoil," Working Papers 2011-02, CEPII research center.
  • Handle: RePEc:cii:cepidt:2011-02
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    References listed on IDEAS

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    1. 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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    5. Jesús Gonzalo & Jean-Yves Pitarakis, 2006. "Threshold Effects in Cointegrating Relationships," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 68(s1), pages 813-833, December.
    6. 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.
    7. Jan De Wit, 2006. "Exploring the CDS-Bond Basis," Working Paper Research 104, National Bank of Belgium.
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    10. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2005. "An Empirical Analysis of the Dynamic Relation between Investment-Grade Bonds and Credit Default Swaps," Journal of Finance, American Finance Association, vol. 60(5), pages 2255-2281, October.
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    Citations

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    Cited by:

    1. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.
    2. Zlatuse Komarkova & Jitka Lesanovska & Lubos Komarek, 2013. "Analysis of Sovereign Risk Market Indicators: The Case of the Czech Republic," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 63(1), pages 5-24, March.
    3. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    4. Niels C. Thygesen & Robert N. McCauley & Guonan Ma & William R. White & Jakob de Haan & Willem van den End & Jon Frost & Christiaan Pattipeilohy & Mostafa Tabbae & Ernest Gnan & Morten Balling & Paul , 2013. "50 Years of Money and Finance: Lessons and Challenges," SUERF 50th Anniversary Volume - 50 Years of Money and Finance: Lessons and Challenges, SUERF - The European Money and Finance Forum, number 1 edited by Morten Balling & Ernest Gnan.
    5. C. Emre Alper & Lorenzo Forni & Marc Gerard, 2013. "Pricing of Sovereign Credit Risk: Evidence from Advanced Economies during the Financial Crisis," International Finance, Wiley Blackwell, vol. 16(2), pages 161-188, June.
    6. William Arrata & Alejandro Bernales & Virginie Coudert, 2013. "The Effects of Derivatives on Underlying Financial Markets: Equity Options, Commodity Derivatives and Credit Default Swaps," SUERF 50th Anniversary Volume Chapters, SUERF - The European Money and Finance Forum.
    7. Takayasu Ito, 2016. "The behaviour of sovereign CDS and government bond in the Euro zone crisis," International Journal of Monetary Economics and Finance, Inderscience Enterprises Ltd, vol. 9(2), pages 102-114.
    8. Saker Sabkha & Christian De Peretti & Dorra Hmaied, 2017. "International risk spillover in the sovereign credit markets: An empirical analysis," Working Papers hal-01652526, HAL.
    9. 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.
    10. Agata Kliber, 2013. "Influence of the Greek Crisis on the Risk Perception of European Economies," Central European Journal of Economic Modelling and Econometrics, CEJEME, vol. 5(2), pages 125-161, June.

    More about this item

    Keywords

    Financial crisis; Credit default swaps; Bonds; Price discovery process;

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G01 - Financial Economics - - General - - - Financial Crises

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