Premium
The Interactions between the Credit Default Swap and the Bond Markets in Financial Turmoil
Author(s) -
Coudert Virginie,
Gex Mathieu
Publication year - 2013
Publication title -
review of international economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.513
H-Index - 58
eISSN - 1467-9396
pISSN - 0965-7576
DOI - 10.1111/roie.12050
Subject(s) - credit default swap , bond , credit default swap index , market liquidity , corporate bond , bond market , economics , swap (finance) , itraxx , yield (engineering) , financial crisis , credit risk , monetary economics , interest rate swap , financial system , financial economics , finance , credit valuation adjustment , materials science , macroeconomics , credit reference , metallurgy
We analyse the links between credit default swap ( CDS ) and bond spreads in order to determine which one is the leading market in the price discovery process. To do that, we construct a sample of CDS premia and bond spreads on a generic 5‐year bond for 17 financials and 18 sovereigns. First, we run panel vector error correction model estimations, showing that the CDS market has a lead over the bond market for financial institutions. This also holds for high‐yield sovereigns, whereas the reverse is found for low‐yield sovereigns in the core of the euro area. We interpret these results according to the relative liquidity of both markets for different types of entities. Second, we check for nonlinearities in the adjustment process. Results show that the CDS market's lead is amplified when default risk increases, during crisis periods, as well as continuously when CDS premia increase.