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Price discovery in CDS and equity markets: Default risk-based heterogeneity in the systematic investment grade and high yield sectors

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  • Procasky, William J.

Abstract

I examine systematic credit default swap (CDS) and equity markets using investment grade and high yield Markit CDX indices and matched equity portfolios within a vector autoregressive (VAR), asymmetrical Granger causality, and vector autoregressive moving average (VARMA) framework to ascertain whether one market has an advantage over the other in pricing in new information. Contrary to the investment grade sector in which neither the CDS nor the equity market is observed to have an advantage, a strong two-way interactive effect is documented in the high yield sector, indicating certain information is impounded more efficiently by each market, with the CDS’ advantage more pronounced under adverse market conditions and in the bellwether CDX.NA.HY index. These findings indicate investors trade high yield CDS indices much differently than investment grade.

Suggested Citation

  • Procasky, William J., 2021. "Price discovery in CDS and equity markets: Default risk-based heterogeneity in the systematic investment grade and high yield sectors," Journal of Financial Markets, Elsevier, vol. 54(C).
    • Handle: RePEc:eee:finmar:v:54:y:2021:i:c:s1386418120300501
    DOI: 10.1016/j.finmar.2020.100581
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    References listed on IDEAS

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    Cited by:

    1. Foglia, Matteo & Di Tommaso, Caterina & Wang, Gang-Jin & Pacelli, Vincenzo, 2024. "Interconnectedness between stock and credit markets: The role of European G-SIBs in a multilayer perspective," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 91(C).
    2. Procasky, William J. & Yin, Anwen, 2023. "The impact of COVID-19 on the relative market efficiency and forecasting ability of credit derivative and equity markets," International Review of Financial Analysis, Elsevier, vol. 90(C).
    3. Procasky, William J. & Yin, Anwen, 2023. "Identifying the true nature of price discovery and cross-market informational flow in the investment grade CDS and equity markets," The North American Journal of Economics and Finance, Elsevier, vol. 64(C).
    4. Thakerngkiat, Narongdech & Nguyen, Hung T. & Nguyen, Nhut H. & Visaltanachoti, Nuttawat, 2023. "Does fear spur default risk?," International Review of Economics & Finance, Elsevier, vol. 83(C), pages 879-899.
    5. William J. Procasky & Anwen Yin, 2022. "Forecasting high‐yield equity and CDS index returns: Does observed cross‐market informational flow have predictive power?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(8), pages 1466-1490, August.

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    More about this item

    Keywords

    Credit derivatives; Credit spreads; Market efficiency; Price discovery; Lead-lag relationship; CDS indices;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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