No abstract

Did CDS Trading Improve the Market for Corporate Bonds?Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error) and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002-2008, we find that the advent of CDS was largely detrimental -bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specification of our tests.

Did CDS Trading Improve the Market for Corporate Bonds?Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error) and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002-2008, we find that the advent of CDS was largely detrimental -bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specification of our tests.

No abstract

Although the pervasive influence of investor sentiment in equity markets is well documented, little is known about behavioral manifestations in bond markets. In this paper, we explore the impact of investor sentiment on corporate bond yield spreads. Our results reveal that bond yield spreads co-vary with sentiment, and sentiment-driven mispricings and systematic reversal trends are very similar to those for stocks. Bonds appear underpriced (with high yields) during pessimistic periods and overpriced (with low yields) when optimism reigns. Consequent reversals result in predictable trends in post-sentiment yield spreads. When beginning-of-period sentiment is low, subsequent yield spreads are low; high sentiment periods are followed by high spreads. High-yield bonds (low ratings, Industrials and Utilities, extreme maturities or low durations, specially if low rated) demonstrate greater susceptibility to mispricings due to sentiment compared to low-yield bonds. The incremental yield spread gap between highand low-yield bonds converges subsequent to periods of low sentiment, and diverges after high sentiment. Equity attributes marginally influence the impact of sentiment on bond spreads, but mostly for distressed bonds only.