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On the Relationship Between Asian Credit Default Swap and Equity Markets

On the Relationship Between Asian Credit Default Swap and Equity Markets When extended to sovereign issuers, the Merton‐type structural model suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices. In practice, capital structure arbitrage that exploits such relationships should foster the integration of CDS and the stock market and improve price discovery. This paper studies the dynamic relationship between sovereign CDS spreads and stock prices for seven Asian countries for the period from January 2001 to February 2007. We find a strong negative correlation between the CDS spread and the stock index for most Asian countries. A long‐run equilibrium price relationship is found for China, Korea, and Thailand. The limited integration in other countries may arise from market frictions and model applicability. In terms of price discovery, CDS markets play a leading role in five out of seven countries. Therefore, equity investors should span the CDS market for incremental information. The stock market has a feedback effect for two countries and dominates price discovery for only one country. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Asia Business Studies Emerald Publishing

On the Relationship Between Asian Credit Default Swap and Equity Markets

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Publisher
Emerald Publishing
Copyright
Copyright © 2009 Emerald Group Publishing Limited. All rights reserved.
ISSN
1558-7894
DOI
10.1108/15587890980000414
Publisher site
See Article on Publisher Site

Abstract

When extended to sovereign issuers, the Merton‐type structural model suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices. In practice, capital structure arbitrage that exploits such relationships should foster the integration of CDS and the stock market and improve price discovery. This paper studies the dynamic relationship between sovereign CDS spreads and stock prices for seven Asian countries for the period from January 2001 to February 2007. We find a strong negative correlation between the CDS spread and the stock index for most Asian countries. A long‐run equilibrium price relationship is found for China, Korea, and Thailand. The limited integration in other countries may arise from market frictions and model applicability. In terms of price discovery, CDS markets play a leading role in five out of seven countries. Therefore, equity investors should span the CDS market for incremental information. The stock market has a feedback effect for two countries and dominates price discovery for only one country.

Journal

Journal of Asia Business StudiesEmerald Publishing

Published: Oct 16, 2009

Keywords: Sovereign credit default swaps; Capital structure arbitrage; Lead‐lag relationship; Cointegration; VECM

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