The effect of liquidity on the price discovery process in credit derivatives markets in times of financial distress

摘要

This paper analyses the role of liquidity in the price discovery process. Specifically, we focus on the creditderivatives markets in the context of the subprime crisis. We present a theoretical price discovery modelfor the asset swap packages (ASPs), bond and credit default swap (CDS) markets and then we test themodel with data from 2005 to 2009 on Euro-denominated non-financial firms. Our empirical results showthat the ASP market clearly leads the bond market in the price discovery process in all cases, while theleadership between ASPs and CDSs is very sensitive to the appearance of the subprime crisis. Before thecrisis, the CDSs market leads the ASP market, but during the crisis, the ASP market leads the CDS market.The liquidity, measured as the relative number of market participants, helps to explain these results.