Linkages between CDS, bond and stock markets: Evidence from Europe

Nowadays, when information has a significant role in financial markets and is reflected in prices of instruments very rapidly, investors, who are interested in arbitrage, hedging or speculation activities in markets, and other market participants would like to know in which market information is embedded into price more rapidly. The aim of the presented paper is to find out if new information is reflected in prices earlier in credit default swap market or in stock or bond markets and to confirm or disprove whether the theoretical assumptions about the links between markets hold. Panel co-integration tests, panel vector error correction models and panel Granger causality tests are employed to examine the long-term and short-term interactions between markets. Assessing the leading role of chosen market within price discovery process can be beneficial for all market participants within their decision making processes. Our results indicate that the relations between credit default swap and stock markets are in accordance with the theoretical assumptions. The results on the relationship between credit default swap and bond markets met the theoretical assumptions during the crisis period, however the role of these two markets has changed in the post-crisis period.