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Which market drives credit spreads in tranquil and crisis periods? An analysis of the contribution to price discovery of bonds, CDS, stocks and options

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  • Davide Avino

    (ICMA Centre, Henley Business School, University of Reading)

  • Emese Lazar

    (ICMA Centre, Henley Business School, University of Reading)

  • Simone Varotto

    (ICMA Centre, Henley Business School, University)

Abstract

Credit spreads can be derived from the prices of securities traded in different markets. In this paper we investigate the price discovery process in single-name credit spreads obtained from bonds, credit default swaps, equities and equity options. Using a vector error correction model (VECM) of changes in credit spreads for a sample that includes the 2007-2009 financial crisis, we find that during periods of high volatility, price discovery takes place primarily in the option market, whilst the equity market leads the other markets during tranquil periods. By adding GARCH effects to the VECM specification, we also find strong evidence of volatility spillovers from the option market to the other markets in crisis periods. Finally, we show how GARCH models can be used to generate time-varying measures of price discovery.

Suggested Citation

  • Davide Avino & Emese Lazar & Simone Varotto, 2011. "Which market drives credit spreads in tranquil and crisis periods? An analysis of the contribution to price discovery of bonds, CDS, stocks and options," ICMA Centre Discussion Papers in Finance icma-dp2011-17, Henley Business School, University of Reading.
    • Handle: RePEc:rdg:icmadp:icma-dp2011-17
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    File URL: http://www.icmacentre.ac.uk/files/discussion-papers/DP2011-17.pdf
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    References listed on IDEAS

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    Cited by:

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    2. Abid, Ilyes & Dhaoui, Abderrazak & Goutte, Stéphane & Guesmi, Khaled, 2019. "Contagion and bond pricing: The case of the ASEAN region," Research in International Business and Finance, Elsevier, vol. 47(C), pages 371-385.

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    More about this item

    Keywords

    credit spreads; price discovery; volatility spillovers; credit and equity derivatives; information flow;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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