Price discovery of credit spreads in tranquil and crisis periods

Avino, D., Lazar, E. ORCID: https://orcid.org/0000-0002-8761-0754 and Varotto, S. ORCID: https://orcid.org/0000-0001-5328-5327 (2013) Price discovery of credit spreads in tranquil and crisis periods. International Review of Financial Analysis, 30. pp. 242-253. ISSN 1057-5219 doi: 10.1016/j.irfa.2013.08.002

Abstract/Summary

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.

Item Type	Article
URI	https://reading-clone.eprints-hosting.org/id/eprint/33620
Identification Number/DOI	10.1016/j.irfa.2013.08.002
Refereed	Yes
Divisions	Henley Business School > Finance and Accounting
Publisher	Elsevier
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