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Which Market Leads Price Discovery? New Conclusions from a New Test

Author

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  • Feldhütter, Peter
  • Lundén, Felix Akilles

Abstract

We show that the standard Granger causality test for assessing informational efficiency between financial markets is misspecified in the presence of market-microstructure noise, a pervasive feature of financial data. Although the test remains statistically valid, its economic interpretation is flawed: predictability from microstructure noise is misread as information flow. We propose a new test robust to such noise and apply it to credit markets, overturning established results. The corporate bond market, not the CDS market, leads in price discovery; there is no evidence of insider trading in CDS; and bond transactions contain more timely information than quotes.

Suggested Citation

  • Feldhütter, Peter & Lundén, Felix Akilles, 2025. "Which Market Leads Price Discovery? New Conclusions from a New Test," CEPR Discussion Papers 20898, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:20898
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    File URL: https://cepr.org/publications/DP20898
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    Keywords

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    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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