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The effect of liquidity on the price discovery process in credit derivatives markets in times of financial distress

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  • Sergio Mayordomo
  • Juan Ignacio Peña
  • Juan Romo

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.

Suggested Citation

  • Sergio Mayordomo & Juan Ignacio Peña & Juan Romo, 2011. "The effect of liquidity on the price discovery process in credit derivatives markets in times of financial distress," The European Journal of Finance, Taylor & Francis Journals, vol. 17(9-10), pages 851-881, November.
  • Handle: RePEc:taf:eurjfi:v:17:y:2011:i:9-10:p:851-881
    DOI: 10.1080/1351847X.2010.538529
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    Citations

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    Cited by:

    1. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    2. repec:taf:applec:v:49:y:2017:i:8:p:823-843 is not listed on IDEAS
    3. Arce, Oscar & Mayordomo, Sergio & Peña, Juan Ignacio, 2013. "Credit-risk valuation in the sovereign CDS and bonds markets: Evidence from the euro area crisis," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 124-145.
    4. Pavel Gertler & Roman Horvath, 2017. "Market Reading of Central Bankers Words. A High-Frequency Evidence," Working and Discussion Papers WP 2/2017, Research Department, National Bank of Slovakia.
    5. Grégory Levieuge, 2017. "Explaining and forecasting bank loans. Good times and crisis," Applied Economics, Taylor & Francis Journals, vol. 49(8), pages 823-843, February.
    6. Jacob Gyntelberg & Peter Hördahl & Kristyna Ters & Jörg Urban, 2013. "Intraday dynamics of euro area sovereign CDS and bonds," BIS Working Papers 423, Bank for International Settlements.
    7. Jacob Gyntelberg & Peter Hördahl & Kristyna Ters & Jörg Urban, 2017. "Arbitrage costs and the persistent non-zero CDS-bond basis: Evidence from intraday euro area sovereign debt markets," BIS Working Papers 631, Bank for International Settlements.

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