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A. Berndt and A. Ostrovnaya, “Information Flow Between Credit Default Swap, Option and Equity Markets,” (Seminar paper, Carnegie Mellon University, 15 March 2007).

A. Berndt and A. Ostrovnaya, “Information Flow Between Credit Default Swap, Option and Equity Markets,” (Seminar paper, Carnegie Mellon University, 15 March 2007).

Abstract: This paper measures the contribution of the credit default swap (CDS) mar-ket to price discovery relative to equity and equity option markets. We provide a rigorous analysis of whether and to what extent the credit market acquires information prior to the option market, and vice versa. Our results indicate that investors absorb information revealed in the CDS market into option prices within a few days and vice versa. We observe a significant incremental flow of information from CDS to option markets for high-yield firms and following ad-verse earnings announcements. We also provide evidence of strong conditional spillovers from option to CDS markets for highly volatile firms and in the days leading up to accounting scandals or adverse earning announcements. When extending the analysis to include equity, we discover a significant information flow from both credit and option markets to equity markets in the days leading up to adverse credit or option market events. We find evidence for a significant incremental revelation of information in the CDS market relative to equity and equity option markets for high-yield firms, and when news of accounting scandals breaks or adverse earnings announcements are made.