How Do Corporate Factors Affect Price Discovery Process between Equity and Credit Markets?
45 Pages Posted: 2 Sep 2022
Abstract
We conduct price discovery analysis to investigate the lead-lag relationship between equity and CDS (Credit Default Swap) markets within a corporate finance framework. Based on a sample of 89 firms covering investment grade and high yield firms, we detect stationarity and cointegration within a panel framework associated to nine corporate financial characteristics factors related to price volatility, default risk, and company capital structures. With an Expectation Maximisation (EM) Kalman filter applied to deal with nonsynchronicity and microstructure noise in one minute data, we verify its practicability in addressing the issue of missing data in a high frequency modeling setting. Contributing to the ongoing debate over the price discovery process between equity and CDS markets, we detect credit-driven price discovery in equity markets. We demonstrate that price discovery process is more credit market driven when a company’s credit risk increases, which is significantly more prominent for small-sized firms with highly volatile equity price, and increasing default probability.
Keywords: Price discovery, Credit Default Swap, Equity, High-Frequency, Financial Market Microstructure
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