A Case for Europe: The Relationship between Sovereign CDs and Stock Indexes
32 Pages Posted: 19 Dec 2012
Date Written: October 1, 2012
In 2010 we witnessed a major European sovereign debt crisis. By examining the links between sovereign Credit Default Swaps and stock indexes for eight European countries during the period 2007-2010, this paper studies the lead-lag relationships of the two markets which represent a country's credit and market risk. Through the use of a Vector Autoregressive model and a panel data model we find that the stock market plays a leading role during the sample period, but when 2010 is isolated a change in this relationship appears: a key role of sovereign CDS markets – the incorporation of new information emerges. This phenomenon is most significant in countries with high risk spread.
Keywords: sovereign credit risk, sovereign credit derivatives, stock markets, lead-lag relationships
JEL Classification: G15, G14, G20
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