Capital Market Consequences on CDS Mispricing
Posted: 26 Jan 2018 Last revised: 21 Jun 2018
Date Written: May 1, 2018
This paper investigates the CDS pricing errors (CPEs) properties. I find that CPEs can significantly predict future CDS returns reversal. Consistent with mispricing channel, the predictability of CPE is particularly strong for CDS contracts with poor liquidities and for periods with high macro-uncertainty. Further analysis shows that CPEs spillover to future cross-sectional stock risks and returns but exhibit almost no predictive powers for bond returns and options returns with 1-month time-to-maturity. It suggests a closer link between equity markets and CDS markets. Collectively, CPE serves as a significant factor to affect capital market behaviors and has important implications on market efficiencies.
Keywords: Credit Default Swaps; Pricing Errors; Reversal; Leverage Effect; Expected Return
JEL Classification: G12
Suggested Citation: Suggested Citation