Are the U.S. Stock Market and Credit Default Swap Market Related? Evidence from the CDX Indices
Journal of Alternative Investments, Summer 2008
47 Pages Posted: 7 Jul 2008 Last revised: 2 Nov 2009
Date Written: July 7, 2008
This study examines the market-wide relations between the U.S. stock market and the credit default swap (CDS) market for the period of 2001-2007. Results indicate that the lead-lag relationship between the U.S. stock market and the CDS market depends on the credit quality of the underlying reference entity. Specifically, this study finds significant mutual feedback of information between the stock market and the high-yield CDS market in terms of pricing and volatility, while the stock market leads the investment-grade CDS index in the pricing process. The CDS market seems to play a more significant role in volatility spillover than the stock market. That is, volatilities of both the investment-grade and high-yield CDS indices seem to lead the stock market volatility, while the latter has a feedback effect to that of the high-yield CDS market only. Overall, the implication is that market participants should seek information in both markets when they are about to engage in trading and/or hedging.
Keywords: credit default swap (CDS) index, information efficiency, price discovery
JEL Classification: G14, C32
Suggested Citation: Suggested Citation