Credit Risk Management in Greater China

CREDIT RISK MANAGEMENT IN GREATER CHINA

¨ HANS BYSTROM† Department of Economics Lund University PO Box 7082 220 07 Lund Sweden contact: hans.bystrom@nek.lu.se

A BSTRACT. In this paper we focus on market-wide credit protection. More exactly, we look at the newly introduced iTraxx Greater China credit default swap (CDS) index, and assess to what degree this index can be used to protect against market-wide credit risk in the Greater China area. While the iTraxx Greater China CDS index is found to be significantly correlated with both the value and volatility of an equally weighted stock portfolio of the names in the CDS index itself, it is found to move more or less independently from some of the most widely used stock indexes in the Greater China region. Not surprisingly, considering the geographical distribution of the constituents in the iTraxx Greater China index, the major stock indexes covering mainland China are found to be particularly uncorrelated with the CDS index. Based on well known theoretical arguments as well as extensive empirical evidence in the literature, we argue that this makes it difficult to manage credit risk in mainland China using the iTraxx Greater China CDS index. At least until more mainland China names have been included in the CDS index.

Keywords: iTraxx; Greater China; credit default swap index; stock market JEL classification codes: G33; C20

† Corresponding Author: Hans Bystr¨ m, Department of Economics, Lund University, Box 7082, 220 07 Lund, Sweden (Phone: +46 o 46 2229478 Fax: +46 46 2224118 Email: hans.bystrom@nek.lu.se). Financial assistance from Bankforskningsinstitutet is gratefully acknowledged.

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CREDIT RISK MANAGEMENT IN GREATER CHINA

Credit Risk Management in Greater China In this paper we focus on market-wide credit protection. More exactly, we look at the newly introduced iTraxx Greater China credit default swap (CDS) index, and assess to what degree this index can be used to protect against...