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

Hans Byström

No 2005:24, Working Papers from Lund University, Department of Economics

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.

Keywords: credit default swap index; stock market index; stock return volatility (search for similar items in EconPapers)
JEL-codes: C20 G33 (search for similar items in EconPapers)
Pages: 14 pages
Date: 2005-03-11, Revised 2005-05-15
New Economics Papers: this item is included in nep-fin and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (37)

Published in Credit Risk - Models, Derivatives, and Management, Wagner, Niklas (eds.), 2008, pages 69-83, Chapman & Hall.

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