Option-implied correlation between iTraxx Europe Financials and Non-Financials Indexes: A measure of spillover effect in European debt crisis

Cho-Hoi Hui, Chi-Fai Lo and Chun-Sing Lau

Journal of Banking & Finance, 2013, vol. 37, issue 9, 3694-3703

Abstract: This paper proposes an analytic method to estimate the option-implied correlation embedded in options on the iTraxx Europe CDS indexes. The option-implied correlation is suggested as a measure of the spillover effect of default risk between the financial and corporate sectors in Europe. In particular, the correlation between the iTraxx Financials and Non-Financials sub-indexes is estimated from options on the iTraxx Main Index, which is considered as a basket option with the two sub-indexes being its underlyings. The abrupt changes of the realized correlation anticipated information of the corresponding option prices. The sovereign default risk, funding liquidity risk, level of risk aversion, and equity market performance are identified to be significant determinants of the option-implied correlation, implying inter-dependence amongst various markets during the European debt crisis.

Keywords: Credit default swaps; Spillover effect; European debt crisis; Option-implied correlation (search for similar items in EconPapers)
JEL-codes: F30 G13 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:9:p:3694-3703

DOI: 10.1016/j.jbankfin.2013.05.030

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