We know that credit risk can be inferred using stock prices (through the Merton / KMV style models) and the credit default swaps (CDS) are of course all credit risk. So there should be a strong link between the two. The CDS market is all offshore, and I believe it is quite illiquid. Still, Pravin describes a fascinating relationship between the two. He has a striking picture in his article, where the red line is the CDS and the blue line is the stock price:
The stock price and the CDS time-series are both I(1). If I shift them to returns, and thus make them I(0), using the full dataset, I see a relationship where the stock price leads the CDS over a one-two day horizon. In my mind, this emphasises the interlinkages between markets: corporate bonds are tightly linked to the government bond yield curve, but when you focus on the credit risk of a corporate bond, it's tightly linked to equity risk. A position which is long corporate bond and short government bond is pure credit risk: this is what the credit derivatives are about and this is what the stock market is about.
What would be great is to have trading on all these instruments - interest rate derivatives, government bonds, corporate bonds, credit derivatives, equity, equity derivatives - by a unified set of participants with a unified system of markets. That's the `BCD Nexus' idea of the MIFC report, and it's very different from the silo system that we have in India today.