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Credit Default Swaps and Equity Prices: The Itraxx CDS Index Market

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Abstract

In 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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  • Byström, Hans N. E., 2005. "Credit Default Swaps and Equity Prices: The Itraxx CDS Index Market," Working Papers 2005:24, Lund University, Department of Economics, revised 15 May 2005.
  • Handle: RePEc:hhs:lunewp:2005_024
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    File URL: http://project.nek.lu.se/publications/workpap/Papers/WP05_24.pdf
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    Cited by:

    1. Wang, Ping & Moore, Tomoe, 2012. "The integration of the credit default swap markets during the US subprime crisis: Dynamic correlation analysis," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(1), pages 1-15.
    2. Haerri, Matthias & Morkoetter, Stefan & Westerfeld, Simone, 2014. "Sovereign Risk and the Pricing of Corporate Credit Default Swaps," Working Papers on Finance 1423, University of St. Gallen, School of Finance, revised Feb 2015.
    3. Alexander, Carol & Kaeck, Andreas, 2008. "Regime dependent determinants of credit default swap spreads," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 1008-1021, June.
    4. Wisniewski, Tomasz Piotr & Lambe, Brendan John, 2015. "Does economic policy uncertainty drive CDS spreads?," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 447-458.
    5. Abbassi, Puriya & Linzert, Tobias, 2012. "The effectiveness of monetary policy in steering money market rates during the financial crisis," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 945-954.
    6. Carol Alexander & Andreas Kaeck, 2006. "Regimes in CDS Spreads: A Markov Switching Model of iTraxx Europe Indices," ICMA Centre Discussion Papers in Finance icma-dp2006-08, Henley Business School, Reading University.
    7. Giovanni Calice & Christos Ioannidis & Julian Williams, 2011. "Credit Derivatives and the Default Risk of Large Complex Financial Institutions," CESifo Working Paper Series 3583, CESifo.
    8. 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.
    9. Lamia Bekkour & Thorsten Lehnert & Maria Chiara Amadari, 2011. "The Relative Informational Efficiency of Stocks, Options and Credit Default Swaps," LSF Research Working Paper Series 11-04, Luxembourg School of Finance, University of Luxembourg.
    10. Nephil Matangi Maskay, 2010. "Macro-Financial Links and Monetary Policy Management," Research Studies, South East Asian Central Banks (SEACEN) Research and Training Centre, number rp78.

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    More about this item

    Keywords

    credit default swap index; stock market index; stock return volatility;

    JEL classification:

    • C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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