The relative informational efficiency of stocks, options and credit default swaps during the financial crisis

Abstract

Purpose

This paper aims to investigate informational efficiency of stock, options and credit default swap (CDS) markets. Previous research suggests that informed traders prefer equity option and CDS markets over stock markets to exploit their informational advantage. As a result, equity and credit derivative markets contribute more to price discovery compared to stock markets.

Design/methodology/approach

In this study, the authors investigate the dynamics behind informed investors’ trading decisions in European stock, options and CDS markets. This allows to identify the predictive explanatory power of the unique information contained in each market with respect to future stock, CDS and option market movements.

Findings

A lead-lag relation is found between the CDS market and the other markets, in which changes in CDS spreads are able to consistently forecast changes in stock prices and equity options’ implied volatilities, indicating how the fast-growing CDS market seems to play a special role in the price discovery process. Moreover, in contrast to results of US studies, the stock market is found to forecast changes in the other two markets, suggesting that investors also prefer stock market involvement to exploit their information advantages before moving to CDS and option markets. Interestingly, these patterns have only emerged during the recent financial crisis, while before the crisis, the option market was found to be of major importance in the price discovery process.

Originality/value

The authors are the first to study the lead-lag relationship among European stock, option and CDS markets for a large sample period covering the financial crisis.

Citation

Amadori, M.C., Bekkour, L. and Lehnert, T. (2014), "The relative informational efficiency of stocks, options and credit default swaps during the financial crisis", Journal of Risk Finance, Vol. 15 No. 5, pp. 510-532. https://doi.org/10.1108/JRF-04-2014-0044