Price Discovery Of Credit Risk

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Price Discovery Of Credit Risk

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Title: Price Discovery Of Credit Risk
Author: Du, Yibing
Abstract: This study investigates financial markets' price discovery for credit risk across the stock, bond, and credit derivatives markets. This study also examined what factors affect financial market's price discovery for credit risk. Four factors are studied: liquidity, transaction cost, credit ratings and maturities. Using weekly equity, bond and credit default swap market data from January 2000 to October 2007, it is found that stock market and bond market, credit derivative market and bond market are cointegrated for long term credit risk price discovery. In short term, both stock market and credit derivatives market lead the bond market for credit risk price discovery. However, the credit risk price discovery relationship between the stock market and credit derivatives market is unclear both in short term and in long run. The price discovery contribution analysis-Gonzalo and Granger (1996) common factor component and Hasbrouck information share (1995) suggests that stock market provides above 80% of price discovery contribution for credit risk among three markets and credit derivatives market's credit risk price discovery contribution is much less than the stock market, while the bond market contributes the least. Credit ratings only affect the credit risk price discovery among equity, credit derivatives and bond market in long run, but no significant influences of ratings in short term. In long run, high yield rating segments provide more credit risk price discovery than the investment grade rating segments. Little evidence is found in this study about the influences of maturities on the credit risk price discovery process among equity, bond and credit derivatives market. Finally, from this study it is found that liquidity factor plays a significant role in the financial market's credit risk price discovery, which is consistent with the liquidity and trading cost explanations of other previous price discovery researches.
Date: 2009-09-16
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