Good and Bad Credit Contagion: Evidence from Credit Default Swaps
39 Pages Posted: 1 Nov 2009
Date Written: June 1, 2006
This study examines the information transfer effect of credit events across the industry, as captured in the Credit Default Swaps (CDS) and stock markets. Positive correlations across CDS spreads imply dominant contagion effects, whereas negative correlations indicate competition effects. We find strong evidence of dominant contagion effects for Chapter 11 bankruptcies and competition effect for Chapter 7 bankruptcies. We also introduce a purely unanticipated event, which is a large jump in a company’s CDS spread, and find that this leads to the strongest evidence of credit contagion across the industry. These results have important implications for the construction of portfolios with credit-sensitive instruments.
Keywords: credit default swaps, bankruptcy, contagion, market reaction, event study
JEL Classification: G14 , G18, G33
Suggested Citation: Suggested Citation