A. Berndt and A. Ostrovnaya: Information Flow Between Credit Default Swap, Option and Equity Markets

March 15, 2007

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.