Informational efficiency of European equity markets

This study examine the predictive power of Credit Default Swaps (CDS) and the equity markets on currency exchange rate to determine whether the CDS is a better predictor as compared to the equity markets. Data sets used for the study include the Investment Grade (IG) and High Yield (HY) North American CDS indices, and iTraxx Europe index as a representative of the overall credit market conditions in Europe. The Vanguard Total Bond Market Index is included to see if CDS spread is more powerful information container than the bond market. The S&P500 index is used as controller for the effects of the US equity market and the Vanguard European Stock Index for Europe. ASX200 and NZ50 are chosen to represent the equity market conditions in Australia and New Zealand respectively. The Vector Autoregressive (VAR) model is used to analyze the simultaneous relationships between exchange rates and CDS index spreads. Granger causality test is conducted to determine the causal relationship between currency values and CDS spreads. Variance Decomposition or Forecast error variance decomposition is also used to complement the VAR analysis. The VAR analysis investigates that CDS can better capture the information in the market than other investment instruments such as bond. CDS thus may offer arbitrage opportunities for investors. In addition significant Grange-causality effects were found from IG and HY CDS spreads to currencies, which support the CDS spreads as a leading indicator of the several currencies versus US Dollar even in the financial crisis. The results of variance decomposition indicate that the contribution of the CDS market to the currency market is higher in Australian dollar, implying more carry-trades in the market.

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Volatility Spillover Effects in European Equity Markets

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109000002350 ◽

2005 ◽

Vol 40 (2) ◽

pp. 373-401 ◽

Cited By ~ 324

Author(s):

Lieven Baele

Keyword(s):

Regional Integration ◽

Regime Switching ◽

Western Europe ◽

Equity Markets ◽

Spillover Effects ◽

Equity Market ◽

Monetary Integration ◽

Time Varying ◽

Trade Integration ◽

European Equity

AbstractThis paper investigates to what extent globalization and regional integration lead to increasing equity market interdependence. I focus on Western Europe, as this region has gone through a unique period of economic, financial, and monetary integration. More specifically, I quantify the magnitude and time-varying nature of volatility spillovers from the aggregate European (EU) and U.S. market to 13 local European equity markets. To account for time-varying integration, I use a regime-switching model to allow the shock sensitivities to change over time. I find regime switches to be both statistically and economically important. Both the EU and U.S. shock spillover intensity increased substantially over the 1980s and 1990s, though the rise is more pronounced for EU spillovers. Shock spillover intensities increased most strongly in the second half of the 1980s and the first half of the 1990s. I show that increased trade integration, equity market development, and low inflation contribute to the increase in EU shock spillover intensity. I also find evidence for contagion from the U.S. market to a number of local European equity markets during periods of high world market volatility.

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