Hostname: page-component-78c5997874-t5tsf Total loading time: 0 Render date: 2024-11-15T06:36:59.618Z Has data issue: false hasContentIssue false
  • English
  • Français

Related Securities and Equity Market Quality: The Case of CDS

Published online by Cambridge University Press:  06 August 2015

Ekkehart Boehmer ,
Sudheer Chava  and
Heather E. Tookes
Ekkehart Boehmer
Affiliation:
eboehmer@smu.edu.sg, Singapore Management University, Lee Kong Chian School of Business, Singapore 178899, Singapore
Sudheer Chava
Affiliation:
sudheer.chava@scheller.gatech.edu, Georgia Institute of Technology, Scheller College of Business, Atlanta, GA 30308
Heather E. Tookes*
Affiliation:
heather.tookes@yale.edu, Yale School of Management, New Haven, CT 06520.
*
*Corresponding author: heather.tookes@yale.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

We document that equity markets become less liquid and equity prices become less efficient when markets for single-name credit default swap (CDS) contracts emerge. This finding is robust across a variety of market quality measures. We analyze the potential mechanisms driving this result and find evidence consistent with negative trader-driven information spillovers that result from the introduction of CDS. These spillovers greatly outweigh the potentially positive effects associated with completing markets (e.g., CDS markets increase hedging opportunities) when firms and their equity markets are in “bad” states. In “good” states, we find some evidence that CDS markets can be beneficial.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 50 , Issue 3 , June 2015 , pp. 509 - 541
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2015 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Acharya, V. V., and Johnson, T.. “Insider Trading in Credit Derivatives.” Journal of Financial Economics, 84 (2007), 110–141.Google Scholar
Acharya, V. V., and Johnson, T.. “More Insiders, More Insider Trading: Evidence from Private Equity Buyouts.” Journal of Financial Economics, 98 (2010), 500–523.Google Scholar
Altman, E. “Financial Ratios, Discriminant Analysis, and the Prediction of Corporate Bankruptcy.” Journal of Finance, 23 (1968), 589–609.Google Scholar
Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.Google Scholar
Amihud, Y.; Lauterbach, B.; and Mendelson, H.. “The Value of Trading Consolidation: Evidence from the Exercise of Warrants.” Journal of Financial and Quantitative Analysis, 38 (2003), 829–846.Google Scholar
Ashcraft, A., and Santos, J.. “Has the CDS Market Lowered the Cost of Corporate Debt?” Journal of Monetary Economics, 56 (2009), 514–523.CrossRefGoogle Scholar
Asquith, P.; Au, A.; Covert, T.; and Pathak, P.. “The Market for Borrowing Corporate Bonds.” Journal of Financial Economics, 107 (2013), 155–182.Google Scholar
Berndt, A., and Ostrovnaya, A.. “Information Flow between Credit Default Swap, Option and Equity Markets.” Working Paper, Carnegie Mellon University (2007).Google Scholar
Bessembinder, H. “Issues in Assessing Trade Execution Costs.” Journal of Financial Markets, 6 (2003), 233–257.Google Scholar
Bessembinder, H., and Maxwell, W.. “Market Transparency and the Corporate Bond Market.” Journal of Economic Perspectives, 22 (2008), 217–234.Google Scholar
Bessembinder, H.; Maxwell, W.; and Venkataraman, K.. “Market Transparency, Liquidity Externalities, and Institutional Trading Costs in Corporate Bonds.” Journal of Financial Economics, 82 (2006), 251–288.Google Scholar
Beveridge, S., and Nelson, C. R.. “A New Approach to Decomposition of Economic Time Series into Permanent and Transitory Components with Particular Attention to Measurement of the ‘Business Cycle’.” Journal of Monetary Economics, 7 (1981), 151–174.Google Scholar
Bhattacharya, U.; Reny, P. J.; and Spiegel, M.. “Destructive Interference in an Imperfectly Competitive Multi-Security Market.” Journal of Economic Theory, 65 (1995), 136–170.Google Scholar
Biais, B., and Hillion, P.. “Insider and Liquidity Trading in Stock and Options Markets.” Review of Financial Studies, 7 (1994), 743–780.Google Scholar
Blanco, R.; Brennan, S.; and Marsh, I.. “An Empirical Analysis of the Dynamic Relationship between Investment-Grade Bonds and Credit Default Swaps.” Journal of Finance, 60 (2005), 2255–2281.CrossRefGoogle Scholar
Boehmer, E.; Jones, C.; and Zhang, X.. “Which Shorts Are Informed?” Journal of Finance, 63 (2008), 491–527.Google Scholar
Boehmer, E., and Kelley, E. K.. “Institutional Investors and the Informational Efficiency of Prices.” Review of Financial Studies, 22 (2009), 3563–3594.Google Scholar
Cao, C. Q.; Chen, Z.; and Griffin, J. M.. “The Information Content of Option Volume Prior to Takeovers.” Journal of Business, 78 (2005), 1073–1109.Google Scholar
Chan, K.; Chung, P. Y.; and Fong, W.. “The Informational Role of Stock and Option Volume.” Review of Financial Studies, 15 (2002), 1949–1975.Google Scholar
Chava, S.; Ganduri, R.; and Orthanalai, C.. “Are Credit Ratings Still Relevant?” Working Paper, Georgia Institute of Technology (2012).Google Scholar
Chava, S., and Purnanandam, A.. “The Effect of Banking Crisis on Bank-Dependent Borrowers.” Journal of Financial Economics, 99 (2011), 116–135.Google Scholar
Choi, D.; Getmansky, M.; and Tookes, H.. “Convertible Bond Arbitrage, Liquidity Externalities, and Stock Prices.” Journal of Financial Economics, 91 (2009), 227–251.Google Scholar
Chordia, T.; Roll, R.; and Subrahmanyam, A.. “Evidence on the Speed of Convergence to Market Efficiency.” Journal of Financial Economics, 76 (2005), 271–292.Google Scholar
Das, S.; Hanouna, P.; and Sarin, A.. “Accounting-Based versus Market-Based Cross-Sectional Models of CDS Spreads.” Journal of Banking and Finance, 33 (2009), 719–730.CrossRefGoogle Scholar
Das, S.; Kalimipalli, M.; and Nayak, S.. “Did CDS Trading Improve the Market for Corporate Bonds?” Journal of Financial Economics, 111 (2014), 495–525.CrossRefGoogle Scholar
Detemple, J., and Jorion, P.. “Option Listing and Stock Returns: An Empirical Analysis.” Journal of Banking and Finance, 14 (1990), 781–801.CrossRefGoogle Scholar
Dow, J. “Arbitrage, Hedging and Financial Innovation.” Review of Financial Studies, 11 (1998), 739–755.Google Scholar
Easley, D.; O’Hara, M.; and Srinivas, P. S.. “Option Volume and Stock Prices: Evidence on Where Informed Traders Trade.” Journal of Finance, 53 (1998), 431–465.Google Scholar
Edwards, A.; Harris, L.; and Piwowar, M.. “Corporate Bond Market Transaction Costs and Transparency.” Journal of Finance, 62 (2007), 1421–1451.CrossRefGoogle Scholar
Elul, R. “Welfare Effects of Financial Innovation in Incomplete Markets with Several Consumption Goods.” Journal of Economic Theory, 65 (1995), 43–78.CrossRefGoogle Scholar
Goldstein, I.; Li, Y.; and Yang, L.. “Speculation and Hedging in Segmented Markets.” Review of Financial Studies, 27 (2014), 881–922.Google Scholar
Goldstein, M.; Hotchkiss, E.; and Sirri, E.. “Transparency and Liquidity: A Controlled Experiment on Corporate Bonds.” Review of Financial Studies, 20 (2007), 235–273.Google Scholar
Gorton, G. N., and Pennacchi, G. G.. “Security Baskets and Index-Linked Securities.” Journal of Business, 66 (1993), 1–27.CrossRefGoogle Scholar
Goyenko, R. Y.; Holden, C. W.; and Trzcinka, C. A.. “Do Liquidity Measures Measure Liquidity?” Journal of Financial Economics, 92 (2009), 153–181.Google Scholar
Hand, J. R. M.; Holthausen, R. W.; and Leftwich, R. W.. “The Effect of Bond Rating Agency Announcements on Bond and Stock Prices.” Journal of Finance, 47 (1992), 733–752.Google Scholar
Hasbrouck, J. “Assessing the Quality of a Security Market: A New Approach to Transaction Cost Measurement.” Review of Financial Studies, 6 (1993), 191–212.Google Scholar
Hasbrouck, J. “Order Characteristics and Stock Price Evolution: An Application to Program Trading.” Journal of Financial Economics, 41 (1996), 129–149.Google Scholar
Kaniel, R.; Saar, G.; and Titman, S.. “Individual Investor Trading and Stock Returns.” Journal of Finance, 63 (2007), 273–309.Google Scholar
Kumar, R.; Sarin, A.; and Shastri, K.. “The Impact of Options Trading on the Market Quality of the Underlying Security: An Empirical Analysis.” Journal of Finance, 53 (1998), 717–732.Google Scholar
Lee, C., and Ready, M.. “Inferring Trade Direction from Intraday Data.” Journal of Finance, 46 (1991), 733–746.Google Scholar
Madhavan, A. “Market Microstructure: A Survey.” Journal of Financial Markets, 3 (2000), 205–258.Google Scholar
Mayhew, S. “The Impact of Derivatives on Cash Markets: What Have We Learned?” Working Paper, University of Georgia (2000).Google Scholar
Mayhew, S., and Mihov, V.. “How Do Exchanges Select Stocks for Option Listing?” Journal of Finance, 59 (2004), 447–471.Google Scholar
Mayordomo, S.; Peña, J. I.; and Schwartz, E. S.. “Are All Credit Default Swap Databases Equal?” European Financial Management, 20 (2014), 677–713.Google Scholar
Merton, R. “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449–470.Google Scholar
Muravyev, D.; Pearson, N.; and Broussard, J. P.. “Is There Price Discovery in Equity Options?” Journal of Financial Economics, 107 (2013), 259–283.Google Scholar
Norden, L., and Weber, M.. “The Co-Movement of Credit Default Swap, Bond and Stock Markets: An Empirical Analysis.” European Financial Management, 15 (2009), 529–562.Google Scholar
Oehmke, M., and Zawadowski, A.. “The Anatomy of the CDS Market.” Working Paper, Columbia University (2012).Google Scholar
O’Hara, M. Market Microstructure Theory. Oxford: Blackwell Publishers (1995).Google Scholar
O’Hara, M., and Ye, M.. “Is Market Fragmentation Harming Market Quality?” Journal of Financial Economics, 100 (2011), 459–474.Google Scholar
Pan, J., and Poteshman, A.. “The Information in Option Volume for Future Stock Prices.” Review of Financial Studies, 19 (2006), 871–908.CrossRefGoogle Scholar
Roberts, M., and Whited, T.. “Endogeneity in Empirical Corporate Finance.” In Handbook of the Economics of Finance, Vol. 2, Constantinides, G., Harris, M., and Stulz, R., eds. Oxford, UK: Elsevier (2012).Google Scholar
Rosenbaum, P. R., and Rubin, D. B.. “The Central Role of the Propensity Score in Observational Studies for Causal Effects.” Biometrika, 70 (1983), 41–55.Google Scholar
Ross, S. A. “Options and Efficiency.” Quarterly Journal of Economics, 90 (1976), 75–89.Google Scholar
Saretto, A., and Tookes, H.. “Corporate Leverage, Debt Maturity and Credit Supply: The Role of Credit Default Swaps.” Review of Financial Studies, 26 (2013), 1190–1247.Google Scholar
Shea, J. “Instrument Relevance in Multivariate Linear Models: A Simple Measure.” Review of Economics and Statistics, 49 (1997), 348–352.Google Scholar
Stock, J. H., and Yogo, M.. “Testing for Weak Instruments in Linear IV Regression.” In Identification and Inference for Econometric Models: Essays in Honor of Thomas J. Rothenberg, Stock, J. H. and Andrews, D. W. K., eds. New York, NY: Cambridge University Press (2005), 80–108.Google Scholar
Stulz, R. “Credit Default Swaps and the Credit Crisis.” Journal of Economic Perspectives, 24 (2010), 73–92.Google Scholar
Subrahmanyam, A. “A Theory of Trading in Stock Index Futures.” Review of Financial Studies, 4 (1991), 17–51.Google Scholar
Subrahmanyam, M.; Tang, D. Y.; and Wang, S. Q.. “Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk.” Review of Financial Studies, 27 (2014), 2927–2960.CrossRefGoogle Scholar