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Cross-sectional value-weighted average of normalized CDS and equity bid-ask spreads—pre-crisis sample (Weekly: July 2003–December 2006, Cross-Section of 45 Firms)
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In this paper I show that the co-movements between bid-ask spreads of equities and credit default swaps vary over time and increase over crisis periods. The co-movements are strongly related to systematic risk factors and to the theoretical debt-to-equity hedge ratio. I document that hedging and asymmetric information, besides higher funding costs...
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Citations
... In this context, several studies have indicated that a co-movement exists between these markets (e.g. Marra 2017). Hence, short selling should generally involve re-evaluating assessments of corresponding companies' creditworthiness, which then increases the costs of debt (Glantz 2003;Mock and Sauckel 2010). ...
The European Union introduced Regulation 236/2012 in 2012 to address short selling and certain aspects of credit default swaps (CDS). Consequently, a uniform short position disclosure regime was developed, which is used in this paper to examine CDS spreads as a proxy for credit risk around public short sale announcements and evaluate the disclosure policy's relevance from the debtholder's perspective. Existing literature documents short selling regulations’ impacts on the stock market, but no evidence exists from the CDS market. Therefore, we first conduct an event study to examine the effects of different short sale events on corresponding firms’ CDS spreads between 2012 and 2018. Moreover, we use regression analyses to control for several credit risk determinants that may also affect CDS spreads. Our evidence suggests that opening and increasing short positions are perceived as negative information, and in this regard lead to higher CDS spreads. In contrast, CDS spreads tend to be lower if short positions decrease or close. Additionally, we find that negative information ceteris paribus more strongly affects CDS spreads than positive information. Finally, we investigate certain anticipatory reactions when negative news enters the CDS market.
... The rise of systemic risk can be also analysed in terms of illiquidity linkages between equity and CDS markets (Marra, 2016): as a matter of fact, when traders are forced to withdraw their positions due to lack of funding or to higher market risk, liquidity decreases in both markets and its cost rises. ...
The article analyses banks’ credit default swap (CDS) spread determinants, in light of the Eurozone debt crisis. The attention to this aspect is due to the very linkage between banking and sovereign sectors particularly evident during the aforementioned crisis.
The study is conducted on a sample of Eurozone banks over the period 2009–2014 through a feasible generalized least squares (FGLS) linear panel data regression.
The variables adopted are both balance sheet ratios and macroeconomic factors. The main results confirm the attention pointed at the influence of public conditions to the banking sector, as proved by the significance of variables like the 10-year bond yields or the long-term sovereign rating. It is also interesting to observe the output dealing with public debt, which may suggest opportunities not only of investment but also of speculation for banks on the debt itself. Balance sheet ratios, instead, are not significant.
Our study is an additional contribution to the strand of literature that analyses the strong interconnections between the riskiness of banks and the public sector and it is a suggestion to proceed the research with a deeper analysis on systemic risk and its impact on banking CDS spread.
... Nevertheless, VIX index futures lead the equity market (Bekaert & Hoerova, 2014). Unfortunately, this leading relationship may disappear during crisis periods (Marra, 2017). Notwithstanding this outcome, it still provides a viable avenue for further exploration to disentangle the relationships between the equity, credit, and derivative markets. ...
Achieving the required returns for investors is an ongoing challenge. This research investigates asset allocation and the Capital Asset Pricing Model (CAPM). Identification of the appropriate investment index reflecting full diversification and delivering the price for its risk is unresolved. The result is uncertainty to both the returns and risks generated when using the CAPM and the effectiveness of mean-variance optimization for asset allocation. This research argues short futures on the CBOE volatility index (VIX) act as the price of risk in equity markets and show that a linkage exists between the price of equity risk and the price of credit risk in the fixed income markets. Further, most of the Fama-French factors are redundant when using this measure of the price of risk in factor models.
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optimization (MVO) while increasing the probability of achieving ex-ante return expectations. In practice, these findings suggest the irrelevance of input assumptions for MVO, an economic rationale for discounting the liability with the expected asset return for US Public Pensions, and the management of time-varying return and risk improves portfolio efficiency.
... This finding is in line with previous studies of liquidity transmission between CDS and stock markets (e.g. Haas and Reynolds 2017;Jacoby, Jiang, and Theocharides 2009;Marra 2017;Tang and Yan 2008). The unidirectional causal relationship from CDS contracts to stocks also applies in all sub-periods except for bi-directional relations in the pre-crisis and Disclosure#2 sub-periods and no causal link in the ban period. ...
Most studies of the short sales ban of UK financial stocks from September 2008 to January 2009 fail to control for the UK’s worst ever banking crisis and the underlying increase in risk. This paper studies the ban’s impact on the 13 large financials with credit default swaps (CDS) and 20 smaller stocks without CDS. The results reveal that returns of banned stocks Granger cause CDS returns in the pre- and post-ban periods, but causality runs from CDS to stock returns during the ban period. Underlying risk proxied by the CDS probability of default increased during the ban and the immediate pre- and post-ban periods which highlights an endogeneity problem ignored in some studies. This increased risk provides a plausible rationale for why CDS and related equity bid-ask spreads - which increased during the ban period – failed to fall significantly in the post-ban period. Panel regression results indicate that probability of default was an important economic determinant of stock bid-ask spreads during the ban period. Finally, our results suggest that the ban offered direct price support for the smaller non-CDS stocks during the ban period and indirect support for CDS stocks from their pre-ban to their post-ban levels.
... The models also control for industry and year fixed effects. All regressions are heteroskedasticity-controlled and the robust standard errors are given in parentheses *, ** and *** denote significance at the 10, 5, and 1% level, respectively the price discovery process is more pronounced for companies in a downturn (Marra 2016;Marsh and Wagner 2016). It should also be noted that the explanatory power of the regression models is highest for the shorter event windows [-5; ?5] than for the [-20; ...
This paper analyzes the importance of distinguishing between watch-preceded and direct rating changes for the credit default swap (CDS) market by examining a total of 2991 rating change announcements, 1526 watchlist placement announcements, and 430 rating affirmations following watchlist placements. The results show that watch-preceded downgrades do not lead to significant CDS market reactions, while direct downgrades are associated with a significant increase in CDS spread levels. Likewise, we document that watchlist placements for downgrade lead to increases in firms’ CDS spreads. CDS markets do not react to rating upgrades but watchlist placements for upgrade result in an immediate decrease in CDS spreads. Rating affirmations following watchlist placements for downgrade lead to slight reductions in CDS spreads, while affirmations following watchlist placements for upgrade have no effect on CDS spreads. These findings demonstrate the importance for empirical research on the interaction between credit markets and rating announcements to differentiate between watch-preceded and direct rating changes, particularly for rating downgrades.
To examine the propagation of shocks across markets, this paper examines the dynamic connections between three distinct markets: the credit default swaps (CDS), equities, and cross-currency basis swaps (CCBS) of four major individual economies: the Eurozone, the UK, Australia, and Japan. We use CDS spreads, CCBS spreads, and stock market returns to capture sovereign credit risk, dollar funding pressure, and stock market performance, respectively. Our results show that a feedback mechanism connects these markets. Higher CDS spreads induce wider CCBS spreads and declines in stock market returns; positive shocks to CCBS spreads lessen CDS spreads and enhance stock market returns; and positive shocks to the stock market lead to lower CDS spreads and tighter CCBS spreads. These findings are supported by Granger causality analysis and are robust across subperiods and empirical specifications. Underpinning the feedback mechanism is the role of CDS as an indicator of potential default on obligations.
We find that the magnitude of unique credit default swap (CDS) market information (constructed to be orthogonal to contemporaneous and lagged stock returns) declined after recent reforms that increased the level of post-trade regulatory and market transparency for CDSs. Around the same reforms, the ability of this CDS-unique information to predict future stock returns decreased. These results suggest the CDS market has become less of a “hidden” trading venue for informed investors since central clearing and trade reporting started.
Most extant structural credit risk models underestimate credit spreads – a shortcoming known as the credit spread puzzle. We consider a model with priced stochastic asset risk, that is able to fit medium‐ to long‐term spreads. The model, augmented by jumps to help explain short‐term spreads, is estimated on firm‐level data and identifies significant asset variance risk premia. An important feature of the model is the significant time‐variation in risk premia induced by the uncertainty about asset risk. Various extensions are considered, among them optimal leverage and endogenous default.
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