Transmigration Across Price Discovery Categories: Evidence from the U.S. CDS and Equity Markets

Abstract

We examine credit risk price discovery between the U.S. equity and credit default swap (CDS) markets for 174 firms between 2005 and 2009. ] measures, we uncover an interesting price discovery transmigration pattern. Before the global financial crisis (GFC), CDS influences price discovery for 92 firms. During the height of the GFC, it increases to 159 firms, despite rising and increasingly volatile CDS spreads. Although the number of firms decrease post-GFC, it remains high compared to the pre-GFC period. The substantially higher and more volatile CDS spreads present informed speculators attractive trading opportunities in the CDS market that were not available before the GFC.In contrast, the GFC is a credit crisis, and credit risk can be hedged with CDS contracts. Like all derivative markets, the CDS market facilitates risk-sharing. Keynes (1923) argues that risk averse hedgers will pay a premium to take positions against more informed speculators. Figure 1 shows that, prior to mid-2007, CDS spreads were low and tranquil. Trading in the CDS market is conducted mainly by commercial banks, pension funds and insurance firms through their uncorrelated hedging demand associated with idiosyncratic lending and investing activities. With the onset of the GFC, credit risk became a prime concern. Hedgers increased their demand for risk-sharing and were willing to pay a higher premium for protection against default. And it is the higher and more volatile spreads during the GFC that makes the CDS market attractive to informed speculators.Keynes's argument is also consistent with why index futures markets did not attract liquidity from informed speculators during the 1987 crash. Since liquidity risk was the main concern, it was not clear to informed speculators that the demand for hedging market risk would increase. Conversely, the main concern during the GFC was credit risk, and Keynes (1923) implies that a surge in demand and premium offered by hedgers for credit risk-sharing during the GFC will attract more informed speculators into the CDS market.

Price Discovery and Volatility Transmission in Australian Reit Cash and Futures Markets

“…as a result, the futures market no longer follows the cash market during the gfc in terms of price prediction and volatility transmission. these results are broadly consistent with the findings of Xiang et al (2013), who report similar results for the cDS market. for the post-gfc period, the overall mean equation results provide information that is different from the results provided from the period during the GFC but similar to those findings documented from before the GFC.…”

“…McMillan and ulku (2009) have also discussed the importance of investor structure in mitigating mispricing in an emerging futures market. recently Xiang et al (2013) and Chng and Wang (2014) find that the credit default swap (cDS) market took over price discovery leadership from the equities market during the gfc, which the authors attribute to shifts in investor structure caused by the gfc attracting more informed speculators into the derivatives markets.…”

“…Because A-REIT futures are mainly used for hedging purposes, it is reasonable that there is a higher hedging demand for futures during the volatile period. Increased demand and higher premiums from hedgers during the gfc might have attracted more informed speculators into the a-reIt futures market (Xiang et al 2013). Increased speculative trading that is a consequence of the asymmetric information held by certain informed traders thus improves the informational efficiency of the A-REIT futures market (ciner 2006).…”

“…These findings are also consistent with the fact that the a-reIt cash (futures) market has become less volatile (less heavily traded) following the gfc, although it remains more volatile (more heavily traded) than during the pre-gfc period. thus, the demand for risk sharing in the reIt futures market remains strong, and the market remains attractive to informed speculators (Xiang et al 2013).…”

“…Specifically, a sharp increase in the trading volume of a-reIt futures has been experienced since the gfc, which might be attributed to increased hedging activities by institutional investors who are attempting to protect the values of their a-reIts (newell 2010). Importantly, Xiang et al (2013) have also documented that a surge in demand for risk-sharing offered by hedgers during the gfc might have attracted more informed speculators into the futures market. given this possible shift in the investor structure of the a-reIt futures market -which is already distinct from the investor structure of stock futures markets -it is unclear whether findings from the stock futures markets will hold in the reIt market.…”