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Limited arbitrage between equity and credit markets

  • Kapadia, Nikunj
  • Pu, Xiaoling

We document that short-horizon pricing discrepancies across firms' equity and credit markets are common and that an economically significant proportion of these are anomalous, indicating a lack of integration between the two markets. Proposing a statistical measure of market integration, we investigate whether equity–credit market integration is related to impediments to arbitrage. We find that time variation in integration across a firm's equity and credit markets is related to firm-specific impediments to arbitrage such as liquidity in equity and credit markets and idiosyncratic risk. Our evidence provides a potential resolution to the puzzle of why Merton model hedge ratios match empirically observed stock-bond elasticities (Schaefer and Strebulaev, 2008) and yet the model is limited in its ability to explain the integration between equity and credit markets (Collin-Dufresne, Goldstein, and Martin, 2001).

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 105 (2012)
Issue (Month): 3 ()
Pages: 542-564

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Handle: RePEc:eee:jfinec:v:105:y:2012:i:3:p:542-564
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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