The Dynamic Interaction of Credit Default Swaps, Sovereign Bonds, and Stocks in the European Market

The paper focuses on finding the interaction among stock, bonds and CDS markets from a country’s level to get the pattern of lead-lag relationship among three markets. It adopts a three-dimensional VAR model to analyse the lead-lag relationship in the European market of ten countries and different credit quality groups. To gain insight into the influence of debt crisis on the correlation of stock and different industries, the paper also uses the pairwise correlation coefficient method. The paper finds that: Before the debt crisis, stocks took the leading position with respect to bonds and CDS. Bonds are also found in some cases due to the financial crisis in previous years. The countries with low CDS premium do not show significant change during the crisis. The stock market and CDS in the consumer has the lowest correlation and the market is stable. They relate most tightly in the financial market.