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; Duisenberg School of Finance; TILEC
February 1, 2012
Bank of Finland Research Discussion Paper No. 6/2012
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 as measures for economy-wide informational asymmetries over time.
Number of Pages in PDF File: 43
Keywords: credit default swaps, price discovery, informational efficiency, hedging demand
JEL Classification: G12, G15, G21working papers series
Date posted: February 5, 2012
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