Are CLO markets that contagious? Evidence from COVID-19 induced sell-off in the financial markets

Abstract How contagious are the CLO markets? We examine whether the major collateralized loan obligations (CLO) markets – US and EU CLOs – transmitted widespread contagion to other asset markets in H1 2020, a period characterized by the COVID-19-induced market sell-offs. This is to assess whether weaknesses in major CLO markets also contributed to widespread turmoil in the broader financial markets, amid negative shocks and to what extent. We find that, except for corporate bonds, evidence that CLOs were broadly contagious is limited. There was no significant evidence that shocks to CLO markets subsequently manifested in the stock market, and even the reaction of the government bond market was rather weak. This illustrates that, in a crisis, any underperformance of CLOs may not likewise pass to all other markets to the same extent. Hence, as far as market reactions go, CLOs might not be as widely influential on all other markets as was earlier thought.