How Integrated Are Credit and Equity Markets? Evidence from Index Options

Pierre Collin-Dufresne, Benjamin Junge, Anders B. Trolle

    Research output: Contribution to conferencePaperResearchpeer-review

    Abstract

    In recent years, a liquid market for options on a broad credit index (CDX) has developed. We study the extent to which these options are priced consistently with options on a broad equity index (SPX). We consider a rich structural credit risk model in which firm assets follow a jump-diffusion process with idiosyncratic and systematic risk, and we derive analytical expressions for CDX and SPX options. Calibrating the model, we find that it captures many aspects of the joint dynamics of CDX and SPX options. However, it cannot reconcile the relative levels of option prices, suggesting that credit and equity markets are not fully integrated. A strategy of selling CDX call options against SPX put options yields statistically significant average excess returns and high Sharpe ratios.
    Original languageEnglish
    Publication date2020
    Number of pages62
    Publication statusPublished - 2020
    EventThe 47th European Finance Association Annual Meeting. EFA 2020 - Virtual from The Aalto University School of Business, Helsinki, Finland
    Duration: 20 Aug 202021 Aug 2020
    Conference number: 47
    https://efa2020.efa-meetings.org/

    Conference

    ConferenceThe 47th European Finance Association Annual Meeting. EFA 2020
    Number47
    LocationVirtual from The Aalto University School of Business
    CountryFinland
    CityHelsinki
    Period20/08/202021/08/2020
    Internet address

    Keywords

    • Credit risk
    • CDX
    • CDX options
    • SPX
    • SPX options
    • Structural models

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