Price Discovery of Credit Spreads in Tranquil and Crisis Periods

30 Pages Posted: 12 Jul 2011 Last revised: 7 Mar 2019

See all articles by Davide E. Avino

Davide E. Avino

University of Liverpool; Financial Mathematics and Computation Cluster

Emese Lazar

University of Reading - ICMA Centre

Simone Varotto

ICMA Centre - Henley Business School, University of Reading

Date Written: July 29, 2013

Abstract

In this paper we investigate the price discovery process in single-name credit spreads obtained from bond, credit default swap (CDS), equity and equity option prices. We analyse short term price discovery by modelling daily changes in credit spreads in the four markets with a vector autoregressive model (VAR). We also look at price discovery in the long run with a vector error correction model (VECM). We find that in the short term the option market clearly leads the other markets in the sub-prime crisis (2007-2009). During the less severe sovereign debt crisis (2009-2012) and the pre-crisis period, options are still important but CDSs become more prominent. In the long run, deviations from the equilibrium relationship with the option market still lead to adjustments in the credit spreads observed or implied from other markets. However, options no longer dominate price discovery in any of the periods considered. Our findings have implications for traders, credit risk managers and financial regulators.

Keywords: credit spreads, price discovery, volatility spillovers, credit and equity derivatives, information flow

JEL Classification: G01, G12, G14, G20, D8

Suggested Citation

Avino, Davide E. and Lazar, Emese and Varotto, Simone, Price Discovery of Credit Spreads in Tranquil and Crisis Periods (July 29, 2013). International Review of Financial Analysis, Vol. 30, pp. 242-253, 2013. Available at SSRN: https://ssrn.com/abstract=1883692 or http://dx.doi.org/10.2139/ssrn.1883692

Davide E. Avino (Contact Author)

University of Liverpool ( email )

Chatham Street
Liverpool, L69 7ZA
United Kingdom

Financial Mathematics and Computation Cluster

Dublin
Ireland

Emese Lazar

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom
+44 (0)1183 786675 (Phone)
+44 (0)1189 314741 (Fax)

Simone Varotto

ICMA Centre - Henley Business School, University of Reading ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

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