The behavior of Credit Default Swaps

Abstract: Credit Default Swaps (CDS) have been subject to criticism since the break out of the economic turmoil in 2008, triggered by a weak housing market in the USA and the default of the investment bank Lehman Brothers. This essay analyses the relationship between the variance in Swedish stock market and CDS market during 2004 - 2009. The results indicate a negative relationship between the movements in stock price and movements in CDS-spread. Evidence of volatility clusters, ARCH-effects, is found and further test on conditional vari- ance indicate negative news has a higher impact on future variance in spread than positive, which also increase by the magnitude of shock. Variance in stock price partly explains variance in spread for most of the companies.