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Bank of Finland Research Discussion Papers, Bank of Finland

No 6/2012:
Why is price discovery in credit default swap markets news-specific?

Ian W. Marsh () and Wolf Wagner ()

Abstract: We analyse daily lead-lag patterns in US equity and credit default swap (CDS) returns. We first document that equity returns robustly lead CDS returns. However, we find that the CDS-lag is due to common (and not firm-specific) news and arises predominantly in response to positive (instead of negative) equity market news. We provide an explanation for this news-specific price discovery based on dealers in the CDS market exploiting their informational advantage vis--vis institutional investors with hedging demands. In support of this explanation we find that the CDS-lag and its news-specificity are related to various firm-level proxies for hedging demand in the cross-section as well as measures for economy-wide informational asymmetries over time.

Keywords: credit default swaps; price discovery; informational efficiency; hedging demand; (follow links to similar papers)

JEL-Codes: G12; G15; G21; (follow links to similar papers)

41 pages, February 2, 2012

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