Jump Risk in Stock Markets and CDS Premiums: Evidence from Asian Countries

This study empirically analyzes how well the jump risk of the stock market explains the rate of change of CDS premiums, which are used as an alternative measure of credit risk, based on data from seven Asian countries (Korea, Japan, China, India, Indonesia, Malaysia, and Thailand). The present study empirically analyzes the informational role of jump risk in the stock market in terms of fluctuations in CDS premiums in seven countries in Asia. The specific analysis consists of two stages. In the first stage, the jump-diffusion model is applied to the rate of change of the stock index to estimate the volatility that only reflects jump risk and the heteroskedasticity of the GARCH form. In the second stage, an AR(1)-GARCH(1,1) model is applied to the rate of change of the CDS premium. The estimations show that, although the volatility of the stock market can be assumed to have a generally significant effect on changes in the CDS premium, which represents the sovereign default risk, empirical analysis using the jump-diffusion model confirms that the volatility reflecting the jump risk is relatively more important than that reflecting heteroskedasticity. This result can be interpreted as implying that the information inherent in the jump risk represented by sudden changes in the market continuously affects the rates of change of CDS premiums. It also indirectly shows that the CDS market for this global derivative product and the domestic stock market are not economically independent investment markets.