Credit Spreads and Equity Volatility during Periods of Financial Turmoil

  • Katrin Gottschalk Auckland University of Technology
Keywords: Credit Default Swap, Term Structure, Implied Volatility Surface, Factor Decomposition, Market Linkages, Cross-Hedging


We present a joint analysis of the term structure of credit default swap (CDS) spreads and the implied volatility surface for the United States and five European countries from 2007– 2012, a sample period covering both the Global Financial Crisis (GFC) and the European debt crisis. We analyze to which extent effective cross-hedges can be performed between the CDS and equity derivatives markets during these two crises. We find that during a global crisis a breakdown of the relationship between credit risk and equity volatility may occur, jeopardizing any cross-hedging strategy, which happened during the GFC. This stands in sharp contrast to the more localized European debt crisis, during which this fundamental relationship was preserved despite turbulent market conditions for both the CDS and volatility markets.


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Author Biography

Katrin Gottschalk, Auckland University of Technology

Katrin Gottschalk is a Senior Lecturer in Finance at the Auckland University of Technology, New Zealand

How to Cite
Gottschalk, K. (2014). Credit Spreads and Equity Volatility during Periods of Financial Turmoil. Applied Finance Letters, 3(1), 28-39.