The Role of Credit Default Swaps in the Korean Stock Market

This study investigated the role of credit default swaps (CDSs) as a hedge or safe haven asset against risk in the Korean stock market, including the KOSPI and five individual stocks (IBK, KEPCO, POSCO, Shinhan Bank and Samsung Electronics). To this end, this study applied the bivariate dynamic conditional correlation-fractional integrated generalized autoregressive conditional heteroskedasticity (DCC-FIGARCH) model to daily stock-CDS pairs for 2004-2014. The empirical results showed that CDSs serve as an effective hedge against risk in all individual stock indices. In addition, CDSs also play an important role as safe haven assets in times of extreme stock market volatility and during periods of financial crisis in the Korean stock market. These findings support the role of CDSs as strong hedges against risk in the Korean stock market. It seems that portfolio investors should purchase CDSs to protect against the risk of default (systematic) in the Korean stock market.