Publication: The effect of liquidity on the price discovery process in credit derivatives markets in times of financial distress
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2011
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Taylor & Francis Group
Abstract
This paper analyses the role of liquidity in the price discovery process. Specifically, we focus on the credit
derivatives markets in the context of the subprime crisis. We present a theoretical price discovery model
for the asset swap packages (ASPs), bond and credit default swap (CDS) markets and then we test the
model with data from 2005 to 2009 on Euro-denominated non-financial firms. Our empirical results show
that the ASP market clearly leads the bond market in the price discovery process in all cases, while the
leadership between ASPs and CDSs is very sensitive to the appearance of the subprime crisis. Before the
crisis, the CDSs market leads the ASP market, but during the crisis, the ASP market leads the CDS market.
The liquidity, measured as the relative number of market participants, helps to explain these results.
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Keywords
Price discovery, Vector error correction model (VECM), Credit derivatives, Credit spreads
Bibliographic citation
The European journal of finance, v. 17, n. 9-10, 2011, pp. 851-881