Price Discovery Dynamics Of Corporate Credit Default Swaps And Bonds

This paper empirically analyzes in a time-varying context if the U.S. corporate Credit Default Swaps (CDS) and bond markets of 81 reference entities reflect the same information on their prices between October 2004 and December 2010, using OTC traded CDS. The analysis shows that frictions in the theoretical CDS bond parity are larger the lower the reference entity's credit rating and the less stable the global market conditions. The price discovery is unaffected by the reference entities' credit rating and is strongly time-varying, but is constantly leaded by the CDS market over time. The only robust driver of the price discovery is counterparty risk, defined as the risk that the CDS seller defaults, found to be significant only when global markets are exposed to unusual conditions.