Stock Prices and Stock Return Volatilities Implied by the Credit Market
(2016) In Journal of Fixed Income 25(4). p.32-54- Abstract
- In this article, the author compares equity and credit investors' opinions on price formation in the equity market. More exactly, he inverts the CreditGrades model in order to back out credit-implied stock prices and stock return volatilities from credit default swap spreads for companies in the DJIA index. The credit-implied stock prices often deviate significantly from actual stock prices over the long term. Meanwhile, their day-to-day movements are significantly correlated with actual stock returns for most firms in the DJIA. In an attempt to demonstrate potential applications of credit-implied stock prices, the author constructs simple "capital structure arbitrage" trading strategies based on past credit-implied prices. These... (More)
- In this article, the author compares equity and credit investors' opinions on price formation in the equity market. More exactly, he inverts the CreditGrades model in order to back out credit-implied stock prices and stock return volatilities from credit default swap spreads for companies in the DJIA index. The credit-implied stock prices often deviate significantly from actual stock prices over the long term. Meanwhile, their day-to-day movements are significantly correlated with actual stock returns for most firms in the DJIA. In an attempt to demonstrate potential applications of credit-implied stock prices, the author constructs simple "capital structure arbitrage" trading strategies based on past credit-implied prices. These strategies only require the buying and selling of stocks and differ from traditional cross-capital structure strategies by being suitable for retail investors and other investors without access to the credit derivatives market. The credit-implied volatilities, in turn, behave rather similarly to observed stock market volatilities but without any ghost effects. The author demonstrates how an alternative credit-based "fear gauge," comparable to the CBOE VIX but emanating from the credit market, can be constructed using the credit-implied volatilities. He calls this implied volatility index the Credit-Implied Volatility Index (CIVX). Finally, a plot of the entire term structure of implied volatilities demonstrates a distinct maturity volatility skew. (Less)
Please use this url to cite or link to this publication:
https://lup.lub.lu.se/record/0fcffec1-2550-44ac-9759-523333b735b4
- author
- Byström, Hans LU
- organization
- publishing date
- 2016-05-01
- type
- Contribution to journal
- publication status
- published
- subject
- in
- Journal of Fixed Income
- volume
- 25
- issue
- 4
- pages
- 23 pages
- publisher
- Portfolio Management Research
- external identifiers
-
- scopus:84976873290
- ISSN
- 1059-8596
- DOI
- 10.3905/jfi.2016.25.4.032
- language
- English
- LU publication?
- yes
- id
- 0fcffec1-2550-44ac-9759-523333b735b4
- date added to LUP
- 2016-05-06 10:18:53
- date last changed
- 2022-01-30 03:16:35
@article{0fcffec1-2550-44ac-9759-523333b735b4,
abstract = {{In this article, the author compares equity and credit investors' opinions on price formation in the equity market. More exactly, he inverts the CreditGrades model in order to back out credit-implied stock prices and stock return volatilities from credit default swap spreads for companies in the DJIA index. The credit-implied stock prices often deviate significantly from actual stock prices over the long term. Meanwhile, their day-to-day movements are significantly correlated with actual stock returns for most firms in the DJIA. In an attempt to demonstrate potential applications of credit-implied stock prices, the author constructs simple "capital structure arbitrage" trading strategies based on past credit-implied prices. These strategies only require the buying and selling of stocks and differ from traditional cross-capital structure strategies by being suitable for retail investors and other investors without access to the credit derivatives market. The credit-implied volatilities, in turn, behave rather similarly to observed stock market volatilities but without any ghost effects. The author demonstrates how an alternative credit-based "fear gauge," comparable to the CBOE VIX but emanating from the credit market, can be constructed using the credit-implied volatilities. He calls this implied volatility index the Credit-Implied Volatility Index (CIVX). Finally, a plot of the entire term structure of implied volatilities demonstrates a distinct maturity volatility skew.}},
author = {{Byström, Hans}},
issn = {{1059-8596}},
language = {{eng}},
month = {{05}},
number = {{4}},
pages = {{32--54}},
publisher = {{Portfolio Management Research}},
series = {{Journal of Fixed Income}},
title = {{Stock Prices and Stock Return Volatilities Implied by the Credit Market}},
url = {{http://dx.doi.org/10.3905/jfi.2016.25.4.032}},
doi = {{10.3905/jfi.2016.25.4.032}},
volume = {{25}},
year = {{2016}},
}