How Integrated Are Credit and Equity Markets? Evidence From Index Options

118 Pages Posted: 16 Jul 2020 Last revised: 27 Feb 2021

See all articles by Pierre Collin-Dufresne

Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; National Bureau of Economic Research (NBER)

Benjamin Junge

Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne

Anders B. Trolle

Copenhagen Business School - Department of Finance

Date Written: February 16, 2021

Abstract

In recent years, a liquid market for credit index (CDX) options has developed. We study the extent to which these options are priced consistently with S&P 500 (SPX) equity index options. We derive analytical expressions for CDX and SPX options within a rich structural credit risk model. The model captures many aspects of the joint dynamics of CDX and SPX options; however, it cannot reconcile the relative levels of option prices, suggesting that credit and equity markets are not fully integrated. A strategy of selling CDX volatility yields significantly higher average excess returns and Sharpe ratios than selling SPX volatility.

Keywords: Credit Risk, CDX, CDX Options, SPX, SPX Options, Structural Models

JEL Classification: G12, G13

Suggested Citation

Collin-Dufresne, Pierre and Junge, Benjamin and Trolle, Anders B., How Integrated Are Credit and Equity Markets? Evidence From Index Options (February 16, 2021). Swiss Finance Institute Research Paper No. 20-65, Available at SSRN: https://ssrn.com/abstract=3634726 or http://dx.doi.org/10.2139/ssrn.3634726

Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny, Bâtiment Extranef, # 211
40, Bd du Pont-d'Arve
CH-1015 Lausanne, CH-6900
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Benjamin Junge

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny
Extranef 128
Lausanne, CH-1015
Switzerland

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny
Extranef 128
Lausanne, CH-1015
Switzerland

Anders B. Trolle (Contact Author)

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

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