Corporate Vulnerability Index as a Fear Gauge? Exploring the Contagion Effect between US and Korean Markets

This study uses a newly launched Corporate Vulnerability Index (CVI) that measures the probabilities of default and credit risks of individual firms to present evidence of the contagion effect among international financial markets and examines how market credit risks are propagated from the U.S. financial market to the Korean financial market. The authors find that international financial market contagion is propagated mainly through direct foreign trading channels rather than correlated information channels. This study is pioneering in that it applies the CVI, a recently developed and informative, but not much analyzed, index, to examine the responses of the Korean financial market based on the unique dataset provided by the Korea Exchange. The authors report evidence that various Korean financial market indexes and indicators, such as the stock market index (KOSPI 200), index futures (KOSPI 200 futures), implied volatility index (VKOSPI), and net positions of investors in the index futures market, respond to the shocks in the CVI of the S&P 500 Index firms for the U.S. financial market. The empirical results indicate that there is a strong market linkage and contagion effect between the U.S. and Korean financial markets. The authors also suggest the applicability of the CVI as a fear gauge and trading indicator.