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We examine time-varying behaviour and determinants of asset swap (ASW) spreads for 23 iBoxx European corporate bond indexes from January 2006 to January 2009. The results of a Markov switching model suggest that ASW spreads exhibit regime-dependent behaviour. The evidence is particularly strong for Financial and Corporates Subordinated indexes. Stock market volatility determines ASW spread changes in turbulent periods, whereas stock returns tend to affect spread changes in calm periods. While market liquidity affects spreads only in turbulent regimes the level of interest rates is an important determinant of spread changes in both regimes. Finally, we identify stock returns, lagged ASW spread levels, and lagged volatility of ASW spreads as major drivers of the regime shifts. The results are robust in the extended sample (January 2006 to October 2013) that includes a post-crisis period.

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We document a negative and asymmetric contemporaneous relation of European stock and implied volatility returns. The negative relation is significantly more pronounced at the highest quantile of the stock market return distribution (i.e. largest price decrease). The relation between stock returns and implied volatility exhibits differences consistent with European institutional and cultural clusters. For example, German stock market tends to be more responsive to changes in implied volatility compared to UK stock market. In addition, the volatility spread for these two markets persist for a longer period compared to other European volatility spreads. The degree of integration between the leading European (UK, Germany and France) volatility markets, however, is very high and shocks on the implied volatility spread die out within a few days. Our Markov switching model distinguishes three volatility regimes.Large changes in both, implied volatility and stock returns increase the probability that volatility enters a higher (from low to middle and from middle to high) volatility regime. Factor loadings obtained by principal component analysis (PCA) of volatility returns are also regime dependent. Compared to US, the changes in European implied volatility tend to be more driven by tilts and non-linear movements of the volatility term structure. Our findings lend support to the behavioral explanation of the stock return-implied volatility relation and have implications for risk management.JEL classification: C32, G13, G15