Risk Spillovers in Oil-Related CDS, Stock and Credit Markets

Abstract

This paper examines risk transmission and migration among six US measures of credit and market risk during the full period 2004-2011 period and the 2009-2011 recovery subperiod, with a focus on four sectors related to the highly volatile oil price. There are more long-run equilibrium risk relationships and short-run causal relationships among the four oil-related Credit Default Swaps (CDS) indexes, the (expected equity volatility) VIX index and the (swaption expected volatility) SMOVE index for the full period than for the recovery subperiod. The auto sector CDS spread is the most error-correcting in the long run and also leads in the risk discovery process in the short run. On the other hand, the CDS spread of the highly regulated, natural monopoly utility sector does not error correct. The four oil-related CDS spread indexes are responsive to VIX in the short-and long-run, while no index is sensitive to SMOVE which, in turn, unilaterally assembles risk migration from VIX. The 2007-2008 Great Recession seems to have led to "localization" and less migration of credit and market risk in the oil-related sectors.JEL: C13, C22, G1, G12, Q40.

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“…In addition, a dynamic conditional correlation matrix may be obtained only through the standardization in Equation ( 7). However, we can also note an inconsistency between the dynamic conditional expectation reported in Equation ( 5) and the way in which the dynamic conditional correlation matrix is obtained in Equation (7). Such inconsistency causes further problems as t Q is not the conditional covariance of t η , as shown in Equation ( 5), and is not the conditional correlation of t η as it is just positive definite, but need not correspond to a dynamic conditional correlation matrix.…”

“…In particular, there has been great emphasis paid to the analysis of financial assets (see [1] and [2], among others, and the references cited in the surveys by [3] and [4]). More recently, there has been growing interest in energy finance, particularly oil (see [5], [6], [7] and [8] among others).…”

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