Are Credit Default Swaps Still a Sideshow? How Information Flow between Equity and CDS Markets Has Changed Since the Financial Crisis

We examine the information flow between the equity and credit default swap (CDS) markets using firm level returns data before and after the Global Financial Crisis (GFC). Prior to the crisis, the information flow is unidirectional with equity returns leading CDS returns. While equity returns continue to lead CDS returns after the crisis, we find that the speed of adjustment of CDS market to equity market has increased during this period. We also find evidence of bidirectional flow of information between these markets with equity returns also responding to credit protection returns in the post-crisis period. The quicker response of CDS spreads to equity returns during the post-crisis period is mainly observed among entities with lower credit ratings. The response of equity returns to lagged CDS returns during the post-crisis period, on the other hand, is observed among firms across different credit rating categories although the magnitude of the response is higher among those with lower credit ratings