Publication: Pairing market risk with credit risk
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2011-02
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Abstract
This paper uses an exclusive proprietary data set of European Credit Derivatives and VIX
markets, covering a sample of 5 to 7 years, to study the nature of the link between credit
risk and market risk, widely acknowledged in the academic literature. This allows us to
establish cointegration in the VIX and iTraxx/CDS markets in a framework where
arbitrageurs exploit temporary equilibrium mispricing following pairs strategies.
Expected profits, defined in terms of VECM parameters, are positive for all VIX-iTraxx
pairs strategies considered. Markets are integrated in that price discovery on both sides of
the Atlantic reflect the same underlying information with predominant price leadership of
the VIX market over the European CDS market.