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Is default risk priced equally fast in the credit default swap and the stock markets? AN empirical investigation

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  • Tolikas, Konstantinos
  • Topaloglou, Nikolas

Abstract

We examine whether default risk is priced equally fast in the credit default swap (CDS) and the stock markets in the main economic sectors of North America, Europe, the UK, and Asia. We find significant evidence in all of these regions and economic sectors that the stock market leads the price discovery process because it reflects default risk faster than the CDS market. We also find weak evidence that the documented lead-lag relation is not regime-dependent and that is stronger for negative stock market news. Our findings do not confirm the theoretical prediction that the CDS market responds faster than the stock market to changing credit conditions. Consistent with the market selection theories, our findings imply that informed traders prefer to trade default risk mostly in the stock market but uninformed traders mostly in the CDS market.

Suggested Citation

  • Tolikas, Konstantinos & Topaloglou, Nikolas, 2017. "Is default risk priced equally fast in the credit default swap and the stock markets? AN empirical investigation," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 51(C), pages 39-57.
    • Handle: RePEc:eee:intfin:v:51:y:2017:i:c:p:39-57
    DOI: 10.1016/j.intfin.2017.09.029
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    Cited by:

    1. Wang, Ruolin & Basu, Anup & Clements, Adam, 2023. "Are credit default swaps still a sideshow? How information flow between equity and CDS markets has changed since the financial crisis," Global Finance Journal, Elsevier, vol. 57(C).
    2. Antulio N. Bomfim, 2023. "Credit default swaps," Chapters, in: Refet S. Gürkaynak & Jonathan H. Wright (ed.), Research Handbook of Financial Markets, chapter 19, pages 429-450, Edward Elgar Publishing.
    3. Yfanti, Stavroula & Karanasos, Menelaos & Zopounidis, Constantin & Christopoulos, Apostolos, 2023. "Corporate credit risk counter-cyclical interdependence: A systematic analysis of cross-border and cross-sector correlation dynamics," European Journal of Operational Research, Elsevier, vol. 304(2), pages 813-831.
    4. Lutfi Abdul Razak & Mansor H. Ibrahim & Adam Ng, 2020. "Which Sustainability Dimensions Affect Credit Risk? Evidence from Corporate and Country-Level Measures," JRFM, MDPI, vol. 13(12), pages 1-22, December.

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    More about this item

    Keywords

    Credit default swaps; Informational efficiency; Lead-lag relation; Price discovering;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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