Why is Price Discovery in Credit Default Swap Markets News-Specific?
CentER Discussion Paper Discussion Paper Series No. 2012-006
41 Pages Posted: 6 Jan 2012 Last revised: 25 Jan 2012
Date Written: January 25, 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 measures for economy-wide informational asymmetries over time.
Keywords: price discovery, CDS, hedging demand, informational asymmetries
JEL Classification: G12, G15, G21
Suggested Citation: Suggested Citation