Price discovery of credit spreads in tranquil and crisis periods

Davide Avino, Emese Lazar and Simone Varotto ()

International Review of Financial Analysis, 2013, vol. 30, issue C, 242-253

Abstract: In this paper we investigate the price discovery process in single-name credit spreads obtained from bond, credit default swap (CDS), equity and equity option prices. We analyse short term price discovery by modelling daily changes in credit spreads in the four markets with a vector autoregressive model (VAR). We also look at price discovery in the long run with a vector error correction model (VECM). We find that in the short term the option market clearly leads the other markets in the sub-prime crisis (2007–2009). During the less severe sovereign debt crisis (2009–2012) and the pre-crisis period, options are still important but CDSs become more prominent. In the long run, deviations from the equilibrium relationship with the option market still lead to adjustments in the credit spreads observed or implied from other markets. However, options no longer dominate price discovery in any of the periods considered. Our findings have implications for traders, credit risk managers and financial regulators.

Keywords: Credit spreads; Price discovery; CDS; Information flow (search for similar items in EconPapers)
JEL-codes: D8 G01 G12 G14 G20 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Related works:
Working Paper: Price Discovery of Credit Spreads in Tranquil and Crisis Periods (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:30:y:2013:i:c:p:242-253

DOI: 10.1016/j.irfa.2013.08.002

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