%0 Journal Article %A Hans Byström %T Stock Prices and Stock Return Volatilities Implied
by the Credit Market %D 2016 %R 10.3905/jfi.2016.25.4.032 %J The Journal of Fixed Income %P 32-54 %V 25 %N 4 %X In this article, the author compares equity and credit investors’ opinions on price formation in the equity market. More exactly, he inverts the CreditGrades model in order to back out credit-implied stock prices and stock return volatilities from credit default swap spreads for companies in the DJIA index. The credit-implied stock prices often deviate significantly from actual stock prices over the long term. Meanwhile, their day-to-day movements are significantly correlated with actual stock returns for most firms in the DJIA. In an attempt to demonstrate potential applications of credit-implied stock prices, the author constructs simple “capital structure arbitrage” trading strategies based on past credit-implied prices. These strategies only require the buying and selling of stocks and differ from traditional cross-capital structure strategies by being suitable for retail investors and other investors without access to the credit derivatives market. The credit-implied volatilities, in turn, behave rather similarly to observed stock market volatilities but without any ghost effects. The author demonstrates how an alternative credit-based “fear gauge,” comparable to the CBOE VIX but emanating from the credit market, can be constructed using the credit-implied volatilities. He calls this implied volatility index the Credit-Implied Volatility Index (CIVX). Finally, a plot of the entire term structure of implied volatilities demonstrates a distinct maturity volatility skew.TOPICS: Security analysis and valuation, credit default swaps %U https://jfi.pm-research.com/content/iijfixinc/25/4/32.full.pdf