Empirical Evidence on the dependence of credit default swaps and equity prices

Debbie Dupuis, Bruno Remillard
HEC Montreal Management Science Department

Eric Jacquier
CIRANO, CIREQ,  HEC  Montreal Finance Department

Nicolas Papageorgiou
CIRANO, HEC Montreal Finance Department


We investigate the common practice of estimating the dependence structure between credit default swap prices on multi-name credit instruments from the dependence structure of the equity returns of the underlying firms. We find convincing evidence that the practice is inappropriate for high-yield instruments and that it may even be flawed for instruments containing only firms within a sector. To do this, we model individual credit ratings by univariate continuous time Markov chains, and their joint dynamics by copulas. The use of copulas allows us to incorporate our knowledge of the modeling of univariate processes, into a multivariate framework. However, our test and results are robust to the choice of copula.