Inventi Impact: Emerging Economies
publication date: 2011/7/15

TESTING FOR NONLINEAR DEPENDENCE IN THE CREDIT DEFAULT SWAP MARKET
                  Kitty Moloney, Srinivas Raghavendra

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 speci?cations of the GARCH model, and the robustness of the result is veri?ed 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.

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