Do Investors Trade Industry Sector-Based Credit Risk Differently Than Systematic Credit Risk?

Abstract

The authors examine price discovery and informational flow between the industry sector-based subindices of the Markit CDX.NA.IG Index and matched portfolios of stocks to ascertain whether they differ from the composite index and one another, possibly due to differing business risk and exposure to systematic factors or investor preferences. They find that although neither market leads the other in pricing in new information in the systematic markets, sector-based matched equity portfolios persistently lead CDS subindices in capturing this information. The only exception is the technology, media, and telecommunications sector, where they observe a two-way interactive effect. They attribute the effect to the comparatively greater growth prospects in this sector and related investor attention. These findings suggest that investors may trade sector-based CDS indices very differently than systematic indices.

Key Findings

• ▪ Price discovery and informational flow between the industry sector-based subindices of the Markit CDX.NA.IG Index and matched portfolios of stocks differs from the composite index as well as within the sectors themselves. Investors trade sector-based CDS indices very differently than systematic indices, a finding with implications for stakeholders who use CDS indices for their informational content.

• ▪ Although neither market leads the other in pricing in new information in the systematic markets, four of the five sector-based matched equity portfolios lead their respective CDS subindices in capturing this information.

• ▪ There is a two-way interactive information flow within the technology, media, and telecommunications sector, suggesting more investor interest relative to the other sectors.