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Contagion in Credit Default Swap Premiums and Spillover Effects from Bond Liquidity to Stock Returns

Anderson, Mike

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2012, Doctor of Philosophy, Ohio State University, Business Administration.

This dissertation investigates two distinct topics. First, I document an increase in the correlations between credit default swap (CDS) spread changes during the credit crisis and investigates the source of that increase. One possible explanation is that correlations increased because fundamental values became more correlated during the crisis. However, I find that changes in the fundamental determinants of credit risk account for only 20% of the increase in correlations. Further, I show that changes in counterparty risk did not affect correlations during the turmoil. In contrast, I find that changes in liquidity risk contributed to the increase in correlations; however, liquidity alone cannot explain the full increase. Finally, I show that a systematic re-pricing of credit risk, as evidenced by increased volatility in the default risk premium, was the main factor that amplified correlations.

Second, I investigate the causal relationship between bond liquidity and stock returns. Bond prices increase with liquidity, which could positively affect stock returns by decreasing the cost of capital and increasing profitability. To isolate an increase in bond liquidity, I define the initiation of the Trade Reporting and Compliance Engine (TRACE) as an exogenous shock to bond liquidity and conduct an event study. I find a cumulative average abnormal return of 2.2% associated with the Phase 1 (July 1, 2002) dissemination date. Further, I find that firms with larger changes in liquidity, as measured by the imputed roundtrip cost (IRC), have larger average abnormal stock returns. Moreover, firms with a higher probability of Informed trading (PIN) also have larger average abnormal returns. These results hold after controlling for short and long-term debt, leverage and firm size.

Rene Stulz (Committee Chair)
Jack Bao (Committee Member)
Kewei Hou (Committee Member)
138 p.

Recommended Citations

Citations

  • Anderson, M. (2012). Contagion in Credit Default Swap Premiums and Spillover Effects from Bond Liquidity to Stock Returns [Doctoral dissertation, Ohio State University]. OhioLINK Electronic Theses and Dissertations Center. http://rave.ohiolink.edu/etdc/view?acc_num=osu1334406908

    APA Style (7th edition)

  • Anderson, Mike. Contagion in Credit Default Swap Premiums and Spillover Effects from Bond Liquidity to Stock Returns. 2012. Ohio State University, Doctoral dissertation. OhioLINK Electronic Theses and Dissertations Center, http://rave.ohiolink.edu/etdc/view?acc_num=osu1334406908.

    MLA Style (8th edition)

  • Anderson, Mike. "Contagion in Credit Default Swap Premiums and Spillover Effects from Bond Liquidity to Stock Returns." Doctoral dissertation, Ohio State University, 2012. http://rave.ohiolink.edu/etdc/view?acc_num=osu1334406908

    Chicago Manual of Style (17th edition)