Good and Bad Credit Contagion: Evidence from Credit Default Swaps

39 Pages Posted: 1 Nov 2009

See all articles by Philippe Jorion

Philippe Jorion

University of California, Irvine - Paul Merage School of Business

Gaiyan Zhang

University of Missouri at St. Louis - College of Business Administration

Date Written: June 1, 2006

Abstract

This study examines the information transfer effect of credit events across the industry, as captured in the Credit Default Swaps (CDS) and stock markets. Positive correlations across CDS spreads imply dominant contagion effects, whereas negative correlations indicate competition effects. We find strong evidence of dominant contagion effects for Chapter 11 bankruptcies and competition effect for Chapter 7 bankruptcies. We also introduce a purely unanticipated event, which is a large jump in a company’s CDS spread, and find that this leads to the strongest evidence of credit contagion across the industry. These results have important implications for the construction of portfolios with credit-sensitive instruments.

Keywords: credit default swaps, bankruptcy, contagion, market reaction, event study

JEL Classification: G14 , G18, G33

Suggested Citation

Jorion, Philippe and Zhang, Gaiyan, Good and Bad Credit Contagion: Evidence from Credit Default Swaps (June 1, 2006). Journal of Financial Economics, Vol. 84, 2007, Available at SSRN: https://ssrn.com/abstract=1497529

Philippe Jorion

University of California, Irvine - Paul Merage School of Business ( email )

Campus Drive
Irvine, CA 92697-3125
United States
949-824-5245 (Phone)
949-824-8469 (Fax)

Gaiyan Zhang (Contact Author)

University of Missouri at St. Louis - College of Business Administration ( email )

One University Blvd
St. Louis, MO 63121
United States

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