Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we report evidence of significant incremental information revelation in the credit default swap (CDS) mar-ket under circumstances consistent with the use of non-public information by informed banks. Specifically, the information revelation occurs only for negative credit news and for entities that subsequently experience adverse shocks. Moreover the degree of advance information revelation increases with the number of banks that have lend-ing/monitoring relations with a given firm, and this effect is robust to controls for non-informational trade. We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true.

an emPirical Study on the decouPling movementS betWeen corPorate bond

This paper examines the relationship between the new markets for credit default swaps (CDS) and the pricing of syndicated loans to U.S. corporates. We find that changes in CDS spreads have a significantly positive coefficient and explain about 25 % of subsequent monthly changes in aggregate loan spreads during 2000-2005. Moreover, when compared to traditional loan pricing factors, they turn out to be the dominant determinant of loan spreads. In particular, they explain loan rates much better than same rated bonds. This suggests that, even though CDS and bond markets may equally price market credit risk, a substantial part of CDS prices additionally contains loan-specific information. We also find that, over time, new information from CDS markets is incorporated into loans faster, but information from other markets does not. We argue that this indicates that the markets for CDS influence banks ’ loan pricing behavior and thus have an impact on actual financing decisions in the economy.

This paper examines the possibility of using derivative-implied risk premia to explain stock returns. The rapid development of derivative markets has led to the possibility of trading various kinds of risks, such as credit and interest rate risk, separately from each other. This paper uses credit default swaps and equity options to determine risk premia which are then used to form portfolios that are regressed against the returns of stock portfolios. It turns out that both, credit risk and implied volatility, have high explanatory power in regard to stock returns. Especially the returns of distressed stocks are highly dependent on credit risk fluctuations. This finding leads to practical implications, such as cross-hedging opportunities between equity and credit instruments and potentially allows forecasting stock returns based on movements in the credit

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Version: 2009-10-07 Motivated by recent developments in light of the sub-prime and subsequent financial crisis we fit two different vector autoregressive generalized conditional heteroscedastic (VAR-GARCH) models to three financial indices with the aim of understanding the development of dependency structures between credit spreads and other macroeconomic variables. Our analysis includes daily quotes from June 2004 to April 2009 of the iTraxx Europe index, the Dow Jones Euro Stoxx 50 index, and the Dow Jones VStoxx index. We propose a robust, time-varying modeling approach concerning the conditional mean, and a BEKK versus DCC-GARCH approach concerning the conditional covariance. Furthermore we allow for a parsimonious model specification by setting insignificant coefficients to zero. Our empirical results indicate that the autoregressive coefficients vary strongly with time and even change their signs. Well-known interrelations, such as the negative correlation between CDS ’ and stocks are lost through the financial crisis. The conditional covariance estimates in the BEKK and DCC model are fairly similar, given the difference in the number of model parameters. We found evidence of strongly varying conditional variances and correlations, with dependencies increasing after the outbreak of the financial crisis. This knowledge may help to improve decision tools in the financial industry, especially in areas such as asset pricing, portfolio selection, and risk management.

We analyze trading opportunities that arise from differences between the bond and the CDS market. By simultaneously entering a position in a CDS contract and the underlying bond, traders can build a default-risk free position that allows them to repeatedly earn the difference between the bond asset swap spread and the CDS, known as the basis. We show that the basis size is closely related to measures of company-specific credit risk and liquidity, and to market conditions. In analyzing the aggregate profits of these basis trading strategies, we document that dissolving a position leads to significant profit variations, but that attractive risk-return characteristics still apply. The aggregate profits depend on the credit risk, liquidity, and market measures even more strongly than the basis itself, and we show which conditions make long and short basis trades more profitable. Finally, we document the impact of the financial crisis on the profits of long and short basis trades, and show that the formerly more profitable long basis trades experienced stronger profit decreases than short basis trades.

A large literature studies the impact of credit rating announcements on security prices and generally concludes that downgrades are bad news for both bond and stock holders. We show that this general conclusion no longer holds when we look in more detail at the particular circumstances of rating announcements. Specifically, we control for the respective reason cited by the rating agency in its rating report and for a contemporaneous involvement of firms in M&A transactions. We analyze stock returns and credit default swap (CDS) premia around the announcement of both rating reviews and actual rating changes. Our results show that rating announcements are not homogenous events. The size and in some cases even the sign of the market reaction depend on the circumstances of the announcements. This indicates that prior studies may suffer from biases introduced by the specific choice of data sets. We find evidence in favor of the wealth transfer hypothesis which predicts that an increase in leverage should be associated with increasing stock prices and decreasing bond prices. However, a closer look at the data reveals that this evidence is driven by firms which at the same time are also involved in M&A transactions. It is likely that the announcement returns in these cases are driven by other information than the rating information only. Surprisingly, we find that rating

This paper investigates the determinants of Asset Swap Spreads of European bond indices. Our results suggest that credit spreads display significant regime specific dynamics. During periods of financial crisis spreads are highly sensitive to equity market volatility, while in tranquil periods stock returns explain credit spreads in a better way. The level of interest rates is an important factor in both regimes, while the difference between the swap curve and the government bond yield curve- the swap spread- influences credit spreads in periods of increased volatility. We also find evidence of negative autocorrelation of Asset Swap Spread changes in tranquil periods and positive autocorrelation in the volatile regime. Finally an increasing risk-free rate and positive returns in the stock market may decrease the probability of entering the high volatility regime. JEL classification: C13, C32, G12

We use a Naïve Bayesian computational linguistics procedure to code the tone of debt analysts ’ discussions about events that potentially generate debt-equity conflicts of interest. Debt analysts ’ views, as published in their investment reports, are expected to reflect the net effect of such conflict-events on the wealth of debt holders by taking into account the level of protection embedded in debt contracts. We document that debt analysts routinely discuss these conflict events and their interpretation is less negative when debt holders are protected by more restrictive covenants. We also provide evidence that debt analysts ’ views on conflict events are