How Integrated Are Credit and Equity Markets? Evidence From Index Options
118 Pages Posted: 16 Jul 2020 Last revised: 27 Feb 2021
Date Written: February 16, 2021
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: Suggested Citation