Price discovery in the markets for credit risk: A Markov switching approach

We examine price discovery in the Credit Default Swap and corporate bond market. By using a Markov switching framework we are able to analyze the dynamic behavior of the information shares during tranquil and crisis periods. The results show that price discovery takes place mostly on the CDS market. The importance of the CDS market even increases during the more volatile crisis periods. According to a cross sectional analysis liquidity is the main determinant of a market's contribution to price discovery. During the crisis period, however, we also find a positive link between leverage and CDS market information shares. Overall the results indicate that price discovery measures and their determinants change during tranquil and crisis periods, which emphasizes the importance of more exible frameworks, such as Markov switching models.