On the Relationship between Asian Sovereign Credit Default Swap Markets and Equity Markets

Journal of Asian Business Studies, Forthcoming

31 Pages Posted: 1 Nov 2009

See all articles by Kam C. Chan

Kam C. Chan

Western Kentucky University - Department of Accounting and Finance

Hung-Gay Fung

University of Missouri at Saint Louis - College of Business Administration

Gaiyan Zhang

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

Date Written: February 1, 2008

Abstract

The Merton-type structural model, when extended to sovereign issuers, suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices. Capital structure arbitrage strategy that exploits such relationships should foster the integration of CDS and the stock market and improve price discovery. This paper studies the dynamic relationship between sovereign CDS spreads and stock prices for seven Asian countries for the period from January 2001 to February 2007. We find a strong negative correlation between the CDS spread and the stock index for most Asian countries. A long-run equilibrium price relationship is found for China, Korea, and Thailand. The limited integration in other countries may arise from market frictions and model applicability. In terms of price discovery, CDS markets play a leading role in five out of seven countries. The stock market has a feedback effect for two countries and dominates price discovery for only one country. Therefore, equity investors should span the CDS market for incremental information.

Keywords: Sovereign credit default swaps, capital structure arbitrage, price discovery, feedback effect

JEL Classification: G14, G15, C22

Suggested Citation

Chan, Johnny and Fung, Hung-Gay and Zhang, Gaiyan, On the Relationship between Asian Sovereign Credit Default Swap Markets and Equity Markets (February 1, 2008). Journal of Asian Business Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1497538

Johnny Chan

Western Kentucky University - Department of Accounting and Finance ( email )

Bowling Green, KY 42101
United States

Hung-Gay Fung

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

One University Blvd.
487 SSB
St. Louis, MO 63121
United States
314-516-6374 (Phone)

Gaiyan Zhang (Contact Author)

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

One University Blvd
St. Louis, MO 63121
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
310
Abstract Views
1,626
rank
106,752
PlumX Metrics