How Inter-Related is American and European Credit Default Swap Indices Market? : A Search for Transatlantic Kinship

This paper is aimed at analyzing the interdependency between American and European Credit Default Swap (CDS) Indices markets from June 2004 to April 2009. For this exercise, the author has chosen the two most liquid Investment-Grade (IG) CDS indices: CDX.NA.IG of North America & iTraxx.Europe of Europe. Both 5Y and 10Y CDS spreads were considered for this study. A granger-causality test was employed to test the direction of granger-causation between CDX.NA.IG and iTraxx.Europe spreads. In addition, Chow test was employed to test for sensitivity of the underlying interdependency (if any), between the American and European CDS indices, to the onset of 2007 financial crisis. The study's findings reveal prevalence of unidirectional granger causality between 5Y CDX.NA.IG and 5Y iTraxx.Europe. In other words, 5Y CDX.NA.IG spread movements granger-cause iTraxx.Europe spread movements. Further, this underlying dependency is found to be sensitive to the onset of the 2007 financial crisis. On the other hand, 5Y iTraxx.Europe spread movements fail to granger-cause 5Y CDX.NA.IG. Also, this lack of dependency is found to be insensitive to the onset of the 2007 financial crisis. On the 10Y front, the study's findings reveal prevalence of bidirectional granger-causality between 10Y CDX.NA.IG and 10Y iTraxx.Europe spread movements. Also, the underlying bi-directional causality between 10Y CDX.NA.IG and 10Y iTraxx.Europe was found to be sensitive to the onset of 2007 financial crisis