The lead-lag relationship between US industry-level credit and stock markets

Syed Jawad Hussain Shahzad, Safwan Mohd Nor, Nur Azura Sanusi and Ronald Kumar

Journal of Economic Studies, 2017, vol. 44, issue 4, 518-539

Abstract: Purpose - The purpose of this paper is to identify the arbitrage opportunities between US industry-level credit and stock markets with a focus on dynamic lead-lag relationships given that these markets involve heterogeneous agents operating over various time horizons. Design/methodology/approach - The authors use daily data of 11 US industries stock markets and their credit counterparts to model the dynamic dependence and casual nexuses using time-frequency approach, namely, wavelet squared coherence (WTC). Findings - The WTC estimation results show that credit and stock markets are out of phase (counter cyclical) and stock markets lead their credit counterparts. The coherence between two markets increases during financial crises. The banks (utilities) industry credit and stock markets have relatively high (low) dependence. Research limitations/implications - The casual nexuses between stock and credit markets have multilateral dimensions. Greater interest in examining the relationship between stock markets and credit default swap (CDS) spreads emerged as an important albeit a complex area of research, and gained prominence especially at the onset and following the global financial crises of 2007-2008 which clearly showed that the positive views of CDSs contribution in creating a resilient and efficient financial sector was nothing further from the truth. Practical implications - The arbitrage and hedging opportunities between stock and credit markets are industry dependent and vary over investment time horizons. The utilities industry seems attractive for the investment with the objective to exploit arbitrage, but not for hedging. Originality/value - The paper, for the first time, employs time-frequency approach to assess the arbitrage opportunities between US industry-level credit and stock markets.

Keywords: Granger causality; Arbitrage; Credit default swap; Wavelet squared coherence (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:jespps:jes-03-2016-0053

DOI: 10.1108/JES-03-2016-0053

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