Credit Risk Discovery in the Stock and CDS Markets:
Who Leads, When, and Why‘

40 Pages Posted: 28 Jul 2008 Last revised: 18 Dec 2009

Santiago Forte

ESADE Business School, Ramon Llull University

Lidija Lovreta

Autonomous University of Barcelona

Date Written: December 17, 2009

Abstract

This paper analyzes the dynamic relationship between CDS spreads and stock market implied credit spreads (ICS) for a large international set of companies during the period 2002-2004. We find the relationship between these credit spread measures to be stronger, and the probability of the stock market leading credit risk discovery to be higher, at the lower credit quality levels. However, consistent with the argument of insider trading in credit derivatives, we document a positive relationship between the frequency of severe credit downturns and the probability of the CDS market leading price discovery. Apart from these findings, our results suggest a slight informational dominance of the stock market that declines over time.

Keywords: Credit risk, credit default swap, price discovery

JEL Classification: G14

Suggested Citation

Forte, Santiago and Lovreta, Lidija, Credit Risk Discovery in the Stock and CDS Markets: Who Leads, When, and Why‘ (December 17, 2009). Available at SSRN: https://ssrn.com/abstract=1183202 or http://dx.doi.org/10.2139/ssrn.1183202

Santiago Forte

ESADE Business School, Ramon Llull University ( email )

Av. Torreblanca 59
Sant Cugat del Vallès, Barcelona 08172
Spain

HOME PAGE: http://www.santiagoforte.com

Lidija Lovreta (Contact Author)

Autonomous University of Barcelona ( email )

Edifici B, Campus UAB
Bellaterra, Barcelona 08193
Spain

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