News-Specific Price Discovery in Credit Default Swap Markets

We examine the lead and lag relation between equity and credit default swap (CDS) markets. We find that price discovery in equity markets only leads CDS markets following aggregate positive news and not so following other news. While difficult to reconcile with standard asset pricing theories, asymmetric price adjustment is common in goods markets, arising from intermediary power. We provide an explanation for this asymmetry based on dealers exploiting informational advantages vis-à-vis investors with hedging motives. Consistent with this explanation, we find that the patterns we document are related to firm-level proxies for hedging demand, as well as economy-wide measures of information asymmetries.