CDS Trading and Stock Price Crash Risk

58 Pages Posted: 15 Jul 2017  

Jinyu Liu

Tsinghua University - School of Economics and Management

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance

Dragon Yongjun Tang

The University of Hong Kong - School of Economics and Finance

Rui Zhong

Central University of Finance and Economics

Date Written: July 15, 2017

Abstract

In this paper, we examine the impact of credit default swap (CDS) trading on the equity market in terms of stock price crash risk. We document that stock price crash is less likely after the inception of CDS trading. This evidence is consistent with the hypothesis that CDS prices reveal negative information that firms intend to hide, and information flow from the CDS market to the equity markets results in timely adjustment of stock prices and reduction of stock price crashes. We provide further evidence of the information revelation role of CDS trading by showing that CDS trading has stronger effects on reducing crash risk when firms are more likely to hide bad news in public disclosures and when executive compensation incentivizes managers to hide bad news. Our paper offers novel evidence on how a financial innovation in the debt market contributes to the stability in the equity market.

Keywords: Credit Default Swaps, CDS, Stock Crash, Information Spillover

JEL Classification: G10, G14, G32, M41

Suggested Citation

Liu, Jinyu and Ng, Jeffrey and Tang, Dragon Yongjun and Zhong, Rui, CDS Trading and Stock Price Crash Risk (July 15, 2017). Available at SSRN: https://ssrn.com/abstract=3003369

Jinyu Liu

Tsinghua University - School of Economics and Management ( email )

Beijing, Beijing 100084
China
+8613720001753 (Phone)

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Dragon Yongjun Tang (Contact Author)

The University of Hong Kong - School of Economics and Finance ( email )

KKL 1005
Pokfulam Road
Pokfulam
Hong Kong
(852)22194321 (Phone)

Rui Zhong

Central University of Finance and Economics ( email )

39 South College Road
Beijing
China

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