The relative informational efficiency of stocks, options and credit default swaps during the financial crisis

Abstract

Purpose – This paper aims to investigate informational efficiency of stock, options and credit default swap (CDS) markets. Previous research suggests that informed traders prefer equity option and CDS markets over stock markets to exploit their informational advantage. As a result, equity and credit derivative markets contribute more to price discovery compared to stock markets. Design/methodology/approach – In this study, the authors investigate the dynamics behind informed investors’ trading decisions in European stock, options and CDS markets. This allows to identify the predictive explanatory power of the unique information contained in each market with respect to future stock, CDS and option market movements. Findings – A lead-lag relation is found between the CDS market and the other markets, in which changes in CDS spreads are able to consistently forecast changes in stock prices and equity options’ implied volatilities, indicating how the fast-growing CDS market seems to play a special role in the price discovery process. Moreover, in contrast to results of US studies, the stock market is found to forecast changes in the other two markets, suggesting that investors also prefer stock market involvement to exploit their information advantages before moving to CDS and option markets. Interestingly, these patterns have only emerged during the recent financial crisis, while before the crisis, the option market was found to be of major importance in the price discovery process. Originality/value – The authors are the first to study the lead-lag relationship among European stock, option and CDS markets for a large sample period covering the financial crisis.

Is Indian Equity Options Market Suitable for Hedging When the Options Payoff Structure Changes?

“…The empirical literature existing in the options market on price discovery, informational efficiency and cross-market efficiency (Caralla & Mammola, 2000;Ammann & Herriger, 2002) gives inconclusive evidence. The research on relative price discovery in related markets also results in the same (Hentze & Seiler, 2000;Srivastava, 2004;Gupta & Basu, 2007;Amadori, Bekkour, & Lehnert, 2014). Apart from the above theoretical explanations, there is an argument that the options segment in developing markets is not suitable for hedging (Bakshi, Cao, & Chen, 2000).…”