Did CDS Trading Improve the Market for Corporate Bonds?

72 Pages Posted: 10 Mar 2011 Last revised: 30 Aug 2013

See all articles by Sanjiv Ranjan Das

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business

Madhu Kalimipalli

Lazaridis School of Business and Economics, Wilfrid Laurier University

Subhankar Nayak

Wilfrid Laurier University - Financial Services Research Centre

Date Written: June 4, 2013

Abstract

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.

Keywords: CDS, bond market efficiency

JEL Classification: G10, G14

Suggested Citation

Das, Sanjiv Ranjan and Kalimipalli, Madhu and Nayak, Subhankar, Did CDS Trading Improve the Market for Corporate Bonds? (June 4, 2013). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1782298 or http://dx.doi.org/10.2139/ssrn.1782298

Sanjiv Ranjan Das (Contact Author)

Santa Clara University - Leavey School of Business ( email )

Department of Finance
316M Lucas Hall
Santa Clara, CA 95053
United States

HOME PAGE: http://algo.scu.edu/~sanjivdas/

Madhu Kalimipalli

Lazaridis School of Business and Economics, Wilfrid Laurier University ( email )

Waterloo, Ontario N2L 3C5
Canada
519-884-0710 (Phone)

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

Subhankar Nayak

Wilfrid Laurier University - Financial Services Research Centre ( email )

Waterloo, Ontario N2L 3C5
Canada

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