Empirical Analysis Based On The Lead-lag Relationship Between European Credit Default Swap Market And Stock Market

The subprime crisis, which dates back to 2007, is still spreading away from the original country--the US. It is the global financial crisis caused by the credit risk that woke people to the significance of the credit risk.Credit Default Swap is one of the most important credit derivatives that can be used to transfer the default risk. The price is bound up with the probability of the credit event occurring to the reference entity during some period in the future. Besides, Credit Default Swap market has experienced a great boom in the last five years, maturing quickly. In such a market with a large number of dealers trading the default probability of the reference entity, any information related to the credit risk should be delivered in time. This study focuses on the dependency and lead-lag relationship between the Credit Default Swap market and the stock market to explore the system of the information flow among the two. Concerning the non-systematic disturbance, this study chooses the corresponding market-scale index to stand for the two market; and groups the CDS Index into investment-grade and sub-investment-grade to indicate that the credit quality may influence the system of the information flow, and constructs the corresponding stock portfolios in the same way the CDS Indices were built to research the lead-lag relationship between these markets.On the basis of the current literature, with the data from September 20^th ,2007 to April 7^th, 2008 in Europe, this study applies VAR Model and other related econometrical methodology to have such results as follows: Both CDS Indices of investment-grade and sub-investment-grade relate negatively to and lead the stock index. And the investment-grade Credit Default Swap market can influence the stock index more. The investment-grade stock market leads the corresponding Credit Default Swap market while the opposite happens in sub-investment-grade market. These results have been accepted by the robustness tests, proving the stability and reliability. This study can be the reference for the construction of the credit derivatives market in China in the future.