The 2008 Financial Crisis and the Dynamics of Price Discovery Among Stock Prices, CDS Spreads, and Bond Spreads for US Financial Firms
Posted: 20 May 2019
Date Written: May 24, 2012
This paper examines the dynamics of price discovery among three informationally connected markets: the stock market, the bond market, and the CDS market. The recent financial crisis in the US has provided a perfect natural experiment to study the impact of stress on price discovery. We study daily stock prices, CDS spreads, and bond spreads over a four-year period before and during the crisis (2005-2008) for 10 US financial firms. The strong cointegrated relationship between the CDS spread and bond spread and the dominant role of CDS spread in price discovery are stable throughout the sample period. Before the crisis, the stock market played a dominant role in price discovery. During the crisis, we document a much weaker role of the stock market while the CDS market has taken on a more important role becoming the dominant source of information during the financial crisis. We also propose two behavioral explanations for our empirical finding.
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