Pairing Market Risk and Credit Risk

Figuerola-Ferretti, Isabel; Paraskevopoulos, Ioannis

doi:10.2139/ssrn.1553863

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Pairing Market Risk and Credit Risk

85 Pages Posted: 9 Mar 2010 Last revised: 6 Apr 2015

See all articles by Isabel Figuerola-Ferretti

Isabel Figuerola-Ferretti

Charles III University of Madrid - Department of Business Administration

Ioannis Paraskevopoulos

Bankia

There are 2 versions of this paper

Date Written: October 23, 2013

Abstract

This paper uses an exclusive proprietary data set of European Credit Derivatives and VIX markets, covering a sample of 5 to 7 years, to study the nature of the link between credit risk and market risk, widely acknowledged in the academic literature. This allows us to establish cointegration in the VIX and iTraxx/CDS markets in a framework where arbitrageurs exploit temporary equilibrium mispricing following pairs strategies. Expected profits, defined in terms of VECM parameters, are positive for all VIX futures-iTraxx pairs strategies considered. Markets are integrated in that price discovery on both sides of the Atlantic reflect the same underlying information with predominant price leadership of the VIX market over the European CDS market.

Keywords: Cointegration, Price Discovery, Market Risk, Credit Risk, VIX, Itraxx, CDS, Portfolio Replication

JEL Classification: C13, C51, G12, G13, G14

Suggested Citation: Suggested Citation

Figuerola-Ferretti Garrigues, Isabel and Paraskevopoulos, Ioannis, Pairing Market Risk and Credit Risk (October 23, 2013). Available at SSRN: https://ssrn.com/abstract=1553863 or http://dx.doi.org/10.2139/ssrn.1553863