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Economics Research International
Volume 2011 (2011), Article ID 708704, 12 pages
http://dx.doi.org/10.1155/2011/708704
Research Article

Testing for Nonlinear Dependence in the Credit Default Swap Market

J.E. Cairnes School of Business & Economics, National University of Ireland Galway, University Road, Galway, Ireland

Received 14 December 2010; Revised 28 February 2011; Accepted 7 March 2011

Academic Editor: James E. Payne

Copyright © 2011 Kitty Moloney and Srinivas Raghavendra. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract

The objective of this paper is to test for nonlinear dependence in the GARCH residuals of a number of asset classes using nonlinear dynamic tools. The equity and bond market samples appear to be independent once GARCH has been applied, but evidence of nonlinear dependence in the CDS GARCH residuals is found. The sensitivity of this result is analysed by changing the specifications of the GARCH model, and the robustness of the result is verified by applying additional tests of nonlinearity. Evidence of nonlinear dependence in the GARCH residuals of CDS contracts has implications for the accurate modeling of the marginal distribution of the CDS market, for pricing of CDS contracts, for estimating risk neutral default probabilities in the bond market, as well as for bond market hedging strategies.