Informed trading in the CDS and OTM put option markets

May Hu, Paresh Narayan, Jason Park and Peter Verhoeven

International Review of Economics & Finance, 2022, vol. 79, issue C, 353-367

Abstract: This paper investigates the role of liquidity in the price discovery process. Specifically, we focus on how informed traders straddle the credit default swap (CDS) and option markets, with OTM put options particularly, and how their choice where to trade depends on the relative liquidity in these markets. We employ daily data of the two most actively traded North American CDX Investment Grade and High Yield indexes from 2010 to 2018. Our empirical results show that relative liquidity is a key factor in where informed trading occurs in CDS and put option markets. Our results suggest that liquidity is the main factor that determines the leadership of the price discovery process between the two markets. When the CDS market is relatively illiquid, informed investors trade in the options market such as OTM put options.

Keywords: Credit default swap; Options; Cross-market arbitrage; Market efficiency; Informed trading; Price discovery (search for similar items in EconPapers)
JEL-codes: G13 G14 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:79:y:2022:i:c:p:353-367

DOI: 10.1016/j.iref.2022.02.030

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