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Disrupted links between credit default swaps, bonds and equities during the GM and Ford crisis in 2005

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  • Virginie Coudert
  • Mathieu Gex

Abstract

We analyse the crisis experienced by General Motors (GM) and Ford following the downgrading of their credit ratings in May 2005 and its impact on the financial markets. At that time, the Credit Default Swap (CDS) premia of GM and Ford sharply increased; all other CDS premia also rose markedly, but stock markets hardly reacted. We try to determine if the usual links between CDS, bonds and stocks were affected by the crisis. To answer this question, we consider 5-year maturity CDS premia and stock prices for 120 major US and European firms, and construct a generic 5-year bond for each of these firms. We estimate nonlinear Vector Error-Correction Model (VECM) and Vector Autoregressive (VAR) model at the firm level. First, the results show that the CDS market has a lead over the bond market, confirming previous results by Blanco et al. (2005) and Zhu (2006), whereas the stock market tends to lead the CDS market. Second, we show that those markets were somewhat disconnected during the crisis, as their links were significantly loosened.

Suggested Citation

  • Virginie Coudert & Mathieu Gex, 2010. "Disrupted links between credit default swaps, bonds and equities during the GM and Ford crisis in 2005," Applied Financial Economics, Taylor & Francis Journals, vol. 20(23), pages 1769-1792.
    • Handle: RePEc:taf:apfiec:v:20:y:2010:i:23:p:1769-1792
    DOI: 10.1080/09603107.2010.524618
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    References listed on IDEAS

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    1. Weber, Martin & Norden, Lars, 2004. "The Comovement of Credit Default Swap, Bond and Stock Markets: An Empirical Analysis," CEPR Discussion Papers 4674, C.E.P.R. Discussion Papers.
    2. Byström, Hans N. E., 2005. "Credit Default Swaps and Equity Prices: The Itraxx CDS Index Market," Working Papers 2005:24, Lund University, Department of Economics, revised 15 May 2005.
    3. Naohiko Baba & Masakazu Inada, 2007. "Price Discovery of Credit Spreads for Japanese Mega-Banks: Subordinated Bond and CDS," IMES Discussion Paper Series 07-E-06, Institute for Monetary and Economic Studies, Bank of Japan.
    4. Carol Alexander & Andreas Kaeck, 2006. "Regimes in CDS Spreads: A Markov Switching Model of iTraxx Europe Indices," ICMA Centre Discussion Papers in Finance icma-dp2006-08, Henley Business School, University of Reading.
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    3. Mariya Paskaleva & Ani Stoitsova-Stoykova, 2017. "Linkages and Efficiency Between iTraxx Europe and Financial Market Dynamics in South-East Europe Capital Markets in Post-crisis Period," International Journal of Economics and Financial Issues, Econjournals, vol. 7(3), pages 172-179.

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