Abstract
The paper analyzes the relationship between the credit default swaps (CDS) spreads for 5-year CDS in Europe and US, and fundamental macroeconomic variables such as regional stock indices, oil prices, gold prices, and interest rates. The dataset includes consideration of multiple industry sectors in both economies, and it is split in two sections, before and after the global financial crisis. The analysis is carried out using multivariate regression of each index vs. the macroeconomic variables, and a Granger causality test. Both approaches are performed on the change of value of the variables involved. Results show that equity markets lead in price discovery, bidirectional causality between interest rate, and CDS spreads for most sectors involved. There is also bidirectional causality between stock and oil returns to CDS spreads.
Highlights
Credit risk is a topic of major interest among academics and practitioners in Finance, due to the strong linkage between such a risk and the financial wealth of the banking systems around the world.Institutions and regulators are strongly involved in the search for the right way to manage credit risk, for single counterparties and baskets of credit positions, given factors such as default probability, loss given default, and recovery rate.In the last decades, credit derivative rose as a powerful tool to handle credit risk
For the during-crisis period, it appears that there were bidirectional causality and information flows between the change in US banks 5-year Credit default swaps (CDS) and the change in interest rates (US fed funds rate), since both depend on macroeconomic conditions, by the same degree of relationship
It appears that Granger causality runs one way from returns on gold prices returns to change in US banks 5-year CDS indicating that information flow is from lagged returns in gold prices to US banks, again indicating a causation relationship that is not sustained by a correlation measure
Summary
Credit risk is a topic of major interest among academics and practitioners in Finance, due to the strong linkage between such a risk and the financial wealth of the banking systems around the world. The paper analyzes the relationship between selected regional sector-wide CDS spreads, and three macroeconomic variables, namely oil prices, regional interest rates, and gold prices Another limitation is geographical, in that the study is based on a comparison between the drivers of the CDS spreads in Europe and those in the US. The first innovation comes from pushing the issue of interdependency between the financial and the real economy to a different level This analysis is focused on economic sectors, rather than credit ratings or single countries, and it is very different from what has been done by most of the literature to date. The combination of the two above innovative elements allows for an in-depth analysis of the credit conditions, characterizing different production sectors during the rise and fall of the hunt for credit derivatives
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