Time-Varying Price Discovery Dynamics of Corporate Credit Default Swaps and Bonds

Molleyres, Josephine

doi:10.2139/ssrn.2817819

Cited by 2 publications

(1 citation statement)

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“…As far as the firms for which the equilibrium holds are concerned, the empirical measures of Hasbrouck (1995) and Gonzalo and Granger (1995) highlight that the CDS market leads the bond market in determining the price of credit risk. Consecutive studies found the predominance of the CDS market with respect to the bond market in corporate entities (e.g., Zhu 2006;Baba and Inada 2009;Molleyres 2018), and a common point of the aforementioned literature regards the discussion of various market imperfections that can hinder the equal price of the two markets in the long term, making the arbitrage relationship not perfect. Such market imperfections move the so-called ''basis'', defined as the difference between the premium on the CDS and the corresponding bond spread on the same entity and with the same maturity, away from the theoretical value of zero.…”

Section: Price Discovery Mechanisms In Cds and Bond Marketsmentioning

confidence: 99%

Effective transfer entropy to measure information flows in credit markets

Caserini

Pagnottoni

2021

Stat Methods Appl

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In this paper we propose to study the dynamics of financial contagion between the credit default swap (CDS) and the sovereign bond markets through effective transfer entropy, a model-free methodology which enables to overcome the required hypotheses of classical price discovery measures in the statistical and econometric literature, without being restricted to linear dynamics. By means of effective transfer entropy we correct for small sample biases which affect the traditional Shannon transfer entropy, as well as we are able to conduct inference on the estimated directional information flows. In our empirical application, we analyze the CDS and bond market data for eight countries of the European Union, and aim to discover which of the two assets is faster at incorporating the information on the credit risk of the underlying sovereign. Our results show a clear and statistically significant prominence of the bond market for pricing the sovereign credit risk, especially during the crisis period. During the post-crisis period, instead, a few countries behave dissimilarly from the others, in particular Spain and the Netherlands.

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