Title: Regime dependent causality: equity and credit markets

Authors: Ramaprasad Bhar; David B. Colwell; Peipei Wang

Addresses: The Australian School of Business, The University of New South Wales, Sydney 2052, Australia ' The Australian School of Business, The University of New South Wales, Sydney 2052, Australia ' School of Accounting Economics and Finance, Deakin University, Burwood, Victoria 3125, Australia

Abstract: We apply a Markov switching model to investigate the possibility of an asymmetric causal relationship between the volatility process inferred from the iTraxx CDS options market and the implied volatility from the stock index options market. We find strong evidence that the stock market leads the CDS market and the effect of the implied stock market volatility is more significant during the volatile regime. We also find that a large jump in the stock return, up or down, may indeed be followed by a regime shift.

Keywords: regime dependence; credit default swaps; CDS options; equity; implied volatility; credit markets; Markov switching model; stock market volatility.

DOI: 10.1504/IJFMD.2012.053326

International Journal of Financial Markets and Derivatives, 2012 Vol.3 No.1, pp.36 - 44

Received: 16 Apr 2012
Accepted: 06 Nov 2012
Published online: 30 Aug 2014 *

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