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The Linkage Between the Options and Credit Default Swap Markets During the Subprime Mortgage Crisis

Authors


  • We thank the editor, Robert Webb, and an anonymous referee for their valuable comments. We also thank Professor Sohel Azad for helpful suggestions at the 2012 Conference of the Asia-Pacific Association of Derivatives. This study was written while the third author was a full-time faculty member at the Korea Advanced Institute of Science and Technology.

Correspondence author, Department of Finance, Hallym University, 1 Hallymdaehak-gil, Chuncheon, Gangwon-Do, 200-702, Korea. Tel: 82-33-248-1855, Fax: 82-33-256-3424, e-mail: yjpark@hallym.ac.kr

Abstract

This study investigates the linkage between the options and credit default swap (CDS) markets around the subprime mortgage crisis period, using the unit recovery claim (URC). Through estimation of a well-hedging strike price within a firm-specific and time-varying default corridor and consideration of the CDS term structure and firm-specific recovery rate, modified URCs from the two markets are demonstrated to have a tighter linkage. The adjusted URCs show that, after the crisis, the effect of macroeconomic variable on deviations between the two markets increased and the options market's predictive power for the future movement of the CDS market was amplified. © 2013 Wiley Periodicals, Inc. Jrl Fut Mark

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