Intra-Industry Credit Contagion Evidence from the Credit Default Swap Market and the Stock Market

By exploiting a comprehensive dataset of Credit Default Swaps (CDS), we investigate the intra-industry credit contagion effect in the context of Chapter 11 bankruptcy, Chapter 7 liquidation, and other credit events defined by extreme jumps in the CDS spread. Our analysis suggests the following findings: First, the credit contagion effect dominates the competitive effect surrounding Chapter 11 reorganization, while the competitive effect dominates the contagion effect around Chapter 7 liquidation. The contagion effect on industry competitors is found to be stronger in jump events than in Chapter 11 events. Secondly, in relating cross-sectional variations in contagion effect to industry characteristics, it is found that equity return correlation is positively related to CDS changes in the event window for both Chapter 11 bankruptcies and jump events. The industry concentration index contributes negatively to CDS changes in Chapter 11 bankruptcies, but the relation is mixed in jump events. Thirdly, industry distress factor can’t fully explain contagion effect; pure contagion accounts for a majority of the CDS increase of industry competitors when Chapter 11 bankruptcy or a jump event occurs. Fourth, compared to the stock market, contagion effect is much more obvious in the CDS market, exhibiting much less information asymmetry. And fifth, the CDS market leads the stock market in capturing contagion effect.