Working Papers, Department of Economics, Lund University
Hans N. E. Byström
Credit Default Swaps and Equity Prices: The Itraxx CDS Index Market
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; (follow links to similar papers)
JEL-Codes: C20; G33; (follow links to similar papers)
14 pages, March 11, 2005, Revised May 15, 2005
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- This paper is published as:
Byström, Hans N. E., (2008), 'Credit Default Swaps and Equity Prices: The iTraxx CDS Index Market' in Wagner, Niklas (ed.) Credit Risk - Models, Derivatives, and Management, Financial Mathematics Series, Vol. 6, pages 69-83, Chapman & Hall.
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