Price discovery in CDS and equity markets: Default risk-based heterogeneity in the systematic investment grade and high yield sectors

I examine systematic credit default swap (CDS) and equity markets using investment grade and high yield Markit CDX indices and matched equity portfolios within a vector autoregressive (VAR), asymmetrical Granger causality, and vector autoregressive moving average (VARMA) framework to ascertain whether one market has an advantage over the other in pricing in new information. Contrary to the investment grade sector in which neither the CDS nor the equity market is observed to have an advantage, a strong two-way interactive effect is documented in the high yield sector, indicating certain information is impounded more efficiently by each market, with the CDS' advantage more pronounced under adverse market conditions and in the bellwether CDX.NA.HY index. These findings indicate investors trade high yield CDS indices much differently than investment grade. (c) 2020 Elsevier B.V. All rights reserved.