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Jumps in Credit Default Swap Spreads and Stock Returns

Patrick Trutwein, Sanjay Ramchander and Dirk Schiereck
The Journal of Fixed Income Winter 2011, 20 (3) 56-70; DOI: https://doi.org/10.3905/jfi.2011.20.3.056
Patrick Trutwein
is a doctoral student in the Department of Finance, Accounting and Real Estate at the European Business School in Oestrich-Winkel, Germany.
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  • For correspondence: patrick.trutwein@ebs.edu
Sanjay Ramchander
is an associate professor in the Department of Finance and Real Estate at Colorado State University in Fort Collins, CO.
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  • For correspondence: sanjay.ramchander@colostate.edu
Dirk Schiereck
is a professor in the Department of Business, Law and Economics at Tech University Darmstadt in Darmstadt, Germany.
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  • For correspondence: schiereck@bwl.tu-darmstadt.de
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Abstract

The authors examine the impact of large changes in singleissuer credit default swap (CDS) spreads on the underlying entity’s equity prices. They consider a sample of 633 significant credit events (or CDS spread changes) relating to 295 U.S. nonfinancial corporations between April 2005 and March 2008. The results indicate that during the period leading up to the financial crisis, equity returns respond positively to both credit widening and contracting events. The evidence during the pre-crisis period supports the view that equity investors do not perceive debt-deteriorating events to be necessarily value-deteriorating for shareholders. In contrast, during the financial crisis period, the authors observe an entirely inverse relationship between CDS spread jumps and equity price movements, particularly for firms with speculative-grade bonds. The findings support the conclusion that the relationship between equity and credit markets is regime dependent and that stock prices seem to anticipate changes from widening CDS spreads.

TOPICS: Credit default swaps, equity portfolio management, financial crises and financial market history

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The Journal of Fixed Income: 20 (3)
The Journal of Fixed Income
Vol. 20, Issue 3
Winter 2011
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Jumps in Credit Default Swap Spreads and Stock Returns
Patrick Trutwein, Sanjay Ramchander, Dirk Schiereck
The Journal of Fixed Income Dec 2010, 20 (3) 56-70; DOI: 10.3905/jfi.2011.20.3.056

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Jumps in Credit Default Swap Spreads and Stock Returns
Patrick Trutwein, Sanjay Ramchander, Dirk Schiereck
The Journal of Fixed Income Dec 2010, 20 (3) 56-70; DOI: 10.3905/jfi.2011.20.3.056
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    • Abstract
    • SINGLE-NAME CREDIT DEFAULT SWAPS
    • LITERATURE REVIEW
    • DATA AND METHODOLOGY
    • RESULTS
    • CONCLUSIONS
    • ENDNOTES
    • REFERENCES
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