Working Paper: CEPR ID: DP4674
Authors: Lars Norden; Martin Weber
Abstract: This Paper analyses the empirical relationship between credit default swap, bond and stock markets during the period 2000-02. Focusing on the intertemporal comovement, we examine weekly and daily lead-lag relationships in a vector autoregressive model and the adjustment between markets caused by cointegration. First, we find that stock returns lead CDS and bond spread changes. Second, CDS spread changes Granger cause bond spread changes for a higher number of firms than vice versa. Third, the CDS market is significantly more sensitive to the stock market than the bond market and the magnitude of this sensitivity increases when credit quality becomes worse. Finally, the CDS market plays a more important role for price discovery than the corporate bond market.
Keywords: credit derivatives; credit risk; credit spreads; lead-lag relationship
JEL Codes: C32; G10; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sensitivity of CDS spreads to stock returns (G12) | Creditworthiness of firms (G32) |
| Stock returns (G12) | CDS spread changes (E39) |
| Stock returns (G12) | Bond spread changes (E43) |
| CDS spread changes (E39) | Bond spread changes (E43) |
| CDS spread changes (E39) | Bond spread changes (E43) |
| CDS spreads (G12) | Bond spreads (G12) |