Related Securities and Equity Market Quality
Ekkehart Boehmer, EDHEC Business School
Sudheer Chava, Georgia Institute of Technology
Heather Tookes, Yale School of Management

We document that equity markets become less liquid and equity prices become less efficient when markets for single-name credit default swap (CDS) contracts emerge. This finding is robust across a variety of market quality measures. We analyze the potential mechanisms driving this result and find evidence consistent with negative trader-driven information spillovers that result from the introduction of CDS. These spillovers greatly outweigh the potentially positive effects associated with completing markets (e.g., CDS markets increase hedging opportunities) when firms and their equity markets are in “bad” states. In “good” states, we find some evidence that CDS markets can be beneficial.

The introduction of new contracts such as CDSs can change where price discovery primarily occurs for certain types of risk and market quality for correlated securities. The results of this study suggest that the introduction of CDS contracts may have hurt equity market quality.