Why is Price Discovery in Credit Default Swap Markets News-Specific?
Ian W. Marsh
City University London - Sir John Cass Business School
Tilburg University, Department of Economics and the European Banking Center
January 25, 2012
European Banking Center Discussion Paper No. 2012-004
CentER Discussion Paper Discussion Paper Series No. 2012-006
We analyse daily lead-lag patterns in US equity and credit default swap (CDS) returns. We first document that equity returns robustly lead CDS returns. However, we find that the CDS-lag is due to common (and not firm-specific) news and arises predominantly in response to positive (instead of negative) equity market news. We provide an explanation for this news-specific price discovery based on dealers in the CDS market exploiting their informational advantage vis-à-vis institutional investors with hedging demands. In support of this explanation we find that the CDS-lag and its news-specificity are related to various firm-level proxies for hedging demand in the cross section as well measures for economy-wide informational asymmetries over time.
Number of Pages in PDF File: 41
Keywords: price discovery, CDS, hedging demand, informational asymmetries
JEL Classification: G12, G15, G21working papers series
Date posted: January 6, 2012 ; Last revised: January 25, 2012
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