Equities, Credits and Volatilities: A Multivariate Analysis of the European Market During the Sub-Prime Crisis

17 Pages Posted: 26 Oct 2009 Last revised: 25 Jun 2012

See all articles by Irene Schreiber

Irene Schreiber

affiliation not provided to SSRN

Gernot Müller

affiliation not provided to SSRN

C. Klüppelberg

Technische Universität München (TUM)

Niklas Wagner

Passau University

Date Written: June 25, 2012

Abstract

We study the lead-lag dependence between aggregate credit spreads and equity prices as well as implied equity volatility, which is important for proper credit risk assessment. Our analysis includes daily quotes of the iTraxx Europe index, the Dow Jones Euro Stoxx 50 index, and the Dow Jones VStoxx index during the period June 2004 to April 2009, i.e. before and during the subprime financial crisis. We robustly estimate a vector autoregressive (VAR) model, allow for time-varying coefficients and assume a multivariate autoregressive conditional heteroskedastic (ARCH) model of the BEKK-type for the innovations. We find that while the commonly predicted negative relation between asset prices and credit spreads holds during the pre-crisis period, it fails to hold during the subsequent crisis period. Equity returns turn out to be insignificant predictors of spreads during the crisis and spread changes significantly and positively lead changes in equity market volatility. Hence, while information in aggregate spreads is typically not driving aggregate market risk, it well may do so during a period in which severe stress in credit markets spills over to the equity market. In sum our results cast some doubt on the stability of the predictions of structural models of credit risk during periods of market stress.

Keywords: credit risk, credit default swaps, iTraxx index, vector autoregression, multivariate GARCH, BEKK

JEL Classification: G01, C32

Suggested Citation

Schreiber, Irene and Müller, Gernot and Kluppelberg, Claudia and Wagner, Niklas F., Equities, Credits and Volatilities: A Multivariate Analysis of the European Market During the Sub-Prime Crisis (June 25, 2012). Available at SSRN: https://ssrn.com/abstract=1493925 or http://dx.doi.org/10.2139/ssrn.1493925

Irene Schreiber

affiliation not provided to SSRN ( email )

Gernot Müller

affiliation not provided to SSRN ( email )

Claudia Kluppelberg (Contact Author)

Technische Universität München (TUM) ( email )

Center for Mathematical Sciences
D-80290 Munich
Germany

Niklas F. Wagner

Passau University ( email )

Innstrasse 27
Passau, 94030
Germany

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