The Co‐movement of Credit Default Swap, Bond and Stock Markets: an Empirical Analysis

TLDR

The study examines the relationship among CDS, bond, and stock markets from 2000 to 2002. The authors use a vector autoregressive model to analyze monthly, weekly, and daily lead‑lag relationships and cointegration‑driven adjustments among the markets. Stock returns lead CDS and bond spreads; CDS spreads Granger‑cause bond spreads more often; the CDS market is more responsive to stock movements and contributes more to price discovery, especially for lower‑quality, larger‑issue firms and in the US.

Abstract

Abstract We analyse the relationship between credit default swap (CDS), bond and stock markets during 2000–2002. Focusing on the intertemporal co‐movement, we examine monthly, 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 more sensitive to the stock market than the bond market and the strength of the co‐movement increases the lower the credit quality and the larger the bond issues. Finally, the CDS market contributes more to price discovery than the bond market and this effect is stronger for US than for European firms.