Capital Market Consequences on CDS Mispricing

Posted: 26 Jan 2018 Last revised: 21 Jun 2018

See all articles by Hao Cheng

Hao Cheng

Singapore Management University, Lee Kong Chian School of Business

Date Written: May 1, 2018

Abstract

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

Cheng, Hao, Capital Market Consequences on CDS Mispricing (May 1, 2018). Asian Finance Association (AsianFA) 2018 Conference. Available at SSRN: https://ssrn.com/abstract=3109702 or http://dx.doi.org/10.2139/ssrn.3109702

Hao Cheng (Contact Author)

Singapore Management University, Lee Kong Chian School of Business ( email )

469 Bukit Timah Road
Singapore
Singapore

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