Identifying the true nature of price discovery and cross-market informational flow in the investment grade CDS and equity markets

William J. Procasky and Anwen Yin

The North American Journal of Economics and Finance, 2023, vol. 64, issue C

Abstract: We examine the comparative efficiency of systematic investment grade credit default swap (CDS) and equity markets using a time-varying coefficient vector autoregression. This modeling framework enables a view of cross-market informational flow along each point in the time-period under investigation by taking into account parameter instability. We obtain smoothing estimates of parameters capturing such flow between CDS and equity markets using daily data from 2004 to 2019, and measure the strength of flow via relative predictive gains. In contrast to prior studies, we find a two-way interactive effect in which certain types of information are captured more efficiently in prices by each market. We also find that the time-varying coefficient vector autoregression results in superior forecasting gains relative to models not accounting for price discovery. These results have implications for systematic investors, arbitrageurs and stakeholders who monitor systematic markets for their informational content.

Keywords: Market efficiency; Informational flow; Forecast evaluation; CDS indices; Structural break (search for similar items in EconPapers)
JEL-codes: C32 C58 G14 G17 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:64:y:2023:i:c:s1062940822002121

DOI: 10.1016/j.najef.2022.101877

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