Did CDS Trading Improve the Market for Corporate Bonds?
Sanjiv Ranjan Das
Santa Clara University - Leavey School of Business
Lazaridis School of Business and Economics, Wilfrid Laurier University
Wilfrid Laurier University - Financial Services Research Centre
June 4, 2013
Journal of Financial Economics (JFE), Forthcoming
Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error) and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002-2008, we find that the advent of CDS was largely detrimental – bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specifications of our tests.
Number of Pages in PDF File: 72
Keywords: CDS, bond market efficiency
JEL Classification: G10, G14
Date posted: March 10, 2011 ; Last revised: August 30, 2013