Equity Prices, Credit Default Swaps, and Bond Spreads in Emerging Markets

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper examines equilibrium price relationships and price discovery between credit defaul swap (CDS), bond, and equity markets for emerging market sovereign issuers. Findings suggest that CDS and bond spreads converge despite various pressures that arise in the market. In most countries, however, we do not find any equilibrium price relationship between the bond and CDS markets and the equity markets. As for price discovery, our results are mixed. This stands in contrast to the empirical findings on corporate issuers in the United States and Europe.

Sovereign CDS and Bond Pricing Dynamics in Emerging Markets: Does the Cheapest-to-Deliver Option Matter?

“…Pan and Singleton (2006) use data on CDS contracts of several different maturities, in an attempt to separately identify default risk and recovery risk in the context of the Duffie and Singleton (2003) credit pricing framework. Among empirical studies with an emerging-market focus, the paper that appears to be most similar to the dynamic analysis undertaken here is Chan-Lau and Kim (2004), who look for lead-lag relationships among sovereign bond indices, sovereign CDS premiums, and national stock market indexes, reporting somewhat inconclusive results. In comparison, our analysis uses more closely matched credit market data, which enables us to cast our analysis in terms of an arbitrage relation.…”

Sovereign Credit Risk and Stock Markets–Does the Markets’ Dependency Increase with Financial Distress?

“…They find a cointegration relationship between stock prices and CDS spreads for China (since 2005), Thailand and South Korea. On the other hand, the CDS market seems to lead the stock market, which refutes [18] results.…”

“…Chan-Lau and Kim (2004) and Chan et al (2008) [18,19] focus the interaction between sovereign credit markets and stock markets. The former authors study a long-term equilibrium relation between stock index prices, sovereign CDS spreads and bond spreads.…”

“…They do not find a long term equilibrium relationship between stock markets and CDS (bond) markets on the large majority of the analyzed countries (the exceptions are Russia and Venezuela, in which the stock market led price discovery). [19] extend [18] sample to seven Asian countries (China, Korea, Thailand, Japan, Malaysia, Indonesia, and The Philippines) and cover the period 2001-2007. They conclude that CDS spreads and stock prices are negatively correlated in all countries with the exception of China.…”

An Analysis of the Relationship Between the Sovereign Credit Default Swaps and the Stock Market of Pakistan Through Handling Outliers

“…Chan-Lau and Kim (2004) extend Merton's model for sovereign CDS (SCDS) and stock market relationship. Chan et al (2009) argue that SCDS and stock market might get integrated due to the use of capital structure arbitrage.…”