Sectoral and Regional Connectedness: The Case of Credit Default Swap Spreads and Equity Prices

This study focuses on assessing sectoral and regional volatility connectedness within and between Credit Default Swap (CDS) and equity markets. The study analyses two main periods: the crisis-period [01/01/2008 – 31/12/2012] and the after-crisis period [01/01/2013 – 30/06/2017] and considers the following regions: US, UK, EU and Japan. This research contributes further to the existing literature by studying spillovers at sectoral and regional level. The analysis at sector and regional level sheds further insights on the connectedness levels and spillover effects across sectors and regions within the CDS and equity markets. This research uses Multivariate-GARCH models, the Diebold and Yilmaz (2012) connectedness index and the VIRF methodology of Gabauer (2020) and an extension to Gabauer (2020) to determine connectedness and spillover characteristics between sectors and regions for both CDS and equity markets.
Results suggest that during periods of distress, volatility connectedness tends to be higher across sectors and regions. In addition, connectedness between the two asset classes is also higher during the crisis period in line with Merton (1974). The dynamic results using both the Diebold and Yilmaz (2012) and Gabauer (2020) methodology validate the results of the static volatility connectedness indices. The findings of the study provide important implications for policymakers, market participants, asset managers and risk managers.