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

Byström, Hans LU (2008) In Credit Risk - Models, Derivatives, and Management. Financial Mathematics Series 6.
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... (More)
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. (Less)
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Chapter in Book/Report/Conference proceeding
publication status
published
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in
Credit Risk - Models, Derivatives, and Management. Financial Mathematics Series
volume
6
publisher
Chapman and Hall
language
English
LU publication?
yes
id
a33abcf4-113d-415e-9eab-3e140f907c22 (old id 1385254)
date added to LUP
2009-04-20 12:27:16
date last changed
2016-08-29 16:26:45
@misc{a33abcf4-113d-415e-9eab-3e140f907c22,
  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.},
  author       = {Byström, Hans},
  language     = {eng},
  publisher    = {ARRAY(0x9a952c8)},
  series       = {Credit Risk - Models, Derivatives, and Management. Financial Mathematics Series},
  title        = {Credit Default Swaps and Equity Prices: The iTraxx CDS Index Market},
  volume       = {6},
  year         = {2008},
}