Price discovery in the CDS market : the informational role of equity short interest

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalNot applicablepeer-review

3 Scopus Citations
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Author(s)

Detail(s)

Original languageEnglish
Pages (from-to)1116-1148
Journal / PublicationReview of Accounting Studies
Volume21
Issue number4
Early online date22 Jun 2016
Publication statusPublished - Dec 2016
Externally publishedYes

Abstract

This paper documents a negative relation between equity short interest and future returns on credit default swaps (CDS). This relation is most consistent with the theory that equity short interest telegraphs relevant information to secondary market CDS investors about credit spread not transmitted into prices in other ways. The CDS return predictive pattern also strengthens negatively for equity short-interest positions subject to an outward shift in the demand for shortable stocks, which we view as a proxy for the expected benefits of private information (Cohen et al. in J Finance 62(5):2061–2096, 2007). This suggests that features of the shorting market may help explain the lagged response of CDS spreads to equity short interest. Our tests of economic significance, however, do not support the view that the CDS return predictive pattern is strong enough to cover the round-trip cost of trading in the secondary CDS market.

Research Area(s)

  • Credit default swaps, Credit spreads, Equity short interest, Lagged asset price discovery