The relative efficiency of investment grade credit and equity markets

William J. Procasky

International Journal of Financial Markets and Derivatives, 2023, vol. 9, issue 1/2, 43-58

Abstract: I examine the relative efficiency of investment-grade CDS and equity markets using a set of liquidly tradable indices for both markets. Prior research has focused on manually constructed indices created from matched portfolios for the equity market. While this results in a matching of constituents, it only produces a theoretical trading instrument. Moreover, that research has only examined the 5-year CDS maturity whereas I also examine the 10-year, which better matches the indefinite life of a stock. Finally, I investigate the potential for size bias. I observe that the longer-dated CDS maturity and an equally weighted equity index in which large capitalisation bias is removed are informationally inefficient, with the equity market having a relative advantage. While no such advantage is observed in the other indices, overall results indicate liquidly traded indices are not as efficient as manually constructed matched portfolios and arbitrage profits may be possible using specifically paired indices.

Keywords: credit derivatives; market efficiency; price discovery; lead-lag relationship; credit markets; CDS indices. (search for similar items in EconPapers)
Date: 2023
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