The Integration of Credit Default Swap Markets in the Pre and Post-Subprime Crisis in Common Stochastic Trends
SFB 649 Discussion Paper 2014-038
30 Pages Posted: 5 Jan 2017
Date Written: August 29, 2014
Abstract
It was evident that credit default swap (CDS) spreads have been highly correlated during the recent financial crisis. Motivated by this evidence, this study attempts to investigate the extent to which CDS markets across regions, maturities and credit ratings have integrated more in crisis. By applying the Panel Analysis of Non-stationarity in Idiosyncratic and Common components method (PANIC) developed by Bai and Ng (2004), we observe a potential shift in CDS integration between the pre- and post-Lehman collapse period, indicating that the system of CDS spreads is tied to a long-run equilibrium path. This finding contributes to a credit risk management task and also coincides with the missions of Basel III since the more integrated CDS markets could result in correlated default, credit contagion and simultaneous downgrading in the future.
Keywords: Credit default swaps, cointegration, common stochastic trend, correlated default
JEL Classification: C38, G32, E43
Suggested Citation: Suggested Citation