Exploring the Empirical Properties Among Different Credit Risk Indicators for EMU Corporate Index

Abstract

This paper analyses the dynamic properties among different credit risk indicators, by using credit default swap (CDS) spreads, asset swap spread (ASWPS) and the option adjusted spread (OAS) for a sample of firms from the EMU Corporate index of Merrill Lynch, during both pre and post Lehman Brothers bailout. We find that credit risk indicators price equally in the long run for the first part of the sample, while the linkage is less robust for the second. Moreover we show that the estimated no-arbitrage relations differ from those suggested by the theory, reflecting other elements than credit risk into prices. In the short run, the dynamic relation suggest a two-way linkage among different markets for credit risk. Results from long term dynamic analysis suggest that both CDS and ASWPS contribute equally to price discovery, while OAS market moves ahead of the derivative market for the pre-Lehman period, especially for European firms. On the other hand, CDS market is the main forum for credit risk after Lehman bailout, irrespective of geographical areas.