The economic significance of CDS price discovery

Vincent Xiang, Michael T. Chng () and Victor Fang
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Vincent Xiang: Deakin University
Michael T. Chng: Xian-Jiaotong Liverpool University
Victor Fang: Deakin University

Review of Quantitative Finance and Accounting, 2017, vol. 48, issue 1, No 1, 30 pages

Abstract: Abstract Between 2005 and 2009, we document evident time-varying credit risk price discovery between the equity and credit default swap (CDS) markets for 174 US non-financial investment-grade firms. We test the economic significance of a simple portfolio strategy that utilizes fluctuation in CDS spreads as a trading signal to set stock positions, conditional on the CDS price discovery status of the reference entities. We show that a conditional portfolio strategy which updates the list of CDS-influenced firms over time, yields a substantively larger realized return net of transaction cost over the unconditional strategy. Furthermore, the conditional strategy’s Sharpe ratio outperforms a series of benchmark portfolios over the same trading period, including buy-and-hold, momentum and dividend yield strategies.

Keywords: Price discovery; CDS spread; Credit risk; Portfolio strategy (search for similar items in EconPapers)
JEL-codes: G14 G15 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (7)

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DOI: 10.1007/s11156-015-0540-2

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