Paulo Pereira da Silva

The EU Ban on Uncovered Sovereign Credit Default Swaps: Assessing Impacts on Liquidity, Volatility, and Price Discovery

During the recent financial crisis, regulatory authorities banned short positions in various financial markets in attempts to moderate pressure from what were felt to be unfavorable, unwarranted, and largely speculative, price changes. Suppression of undesirable price moves was extended to the realm of sovereign debt in November 2012, when the European Union prohibited “naked” purchases of credit default swaps (CDSs) on sovereign bonds. Buying CDS protection is deemed to be naked if the buyer is not doing so to protect an existing long position in the underlying bonds. Academic theory, and empirical evidence from similar bans on short sales in other markets, suggests that such interference in a competitive financial market generally doesn’t work very well: Market participants find ways around the rule; liquidity is reduced in the constrained market; information flow is degraded and prices can become biased because investors with unfavorable beliefs are eliminated from the market; and volatility may increase. Using a “diff-in-diffs” strategy of contrasting the effect on CDS spreads in the 28 affected countries with those in the 56 unconstrained countries as this regulation went into effect, Silva, Vieira, and Vieira show that credit-spread volatility was reduced by the ban, but liquidity was hurt as bid–ask spreads widened and open interest declined. They also find that price informativeness was reduced, in particular by lengthening the time it took for negative information to enter CDS spreads.

Common-wide information flow in CDS markets: The case of earnings surprises of industry leaders

ABSTRACT This paper examines the way common-wide information is disseminated in credit default swap (CDS) markets. I find strong supporting evidence that earnings announcements of CDS references with greater liquidity and higher credit risk help in predicting the subsequent CDS spread movements of their industry peers. This is consistent with the notion that the earnings announcements of certain firms may contain valuable market- and industry-wide information, which may be utilised afterwards to appraise the financial situation and the creditworthiness of industry peers, thereby influencing their CDS rates. Another major finding is that this common-wide information seems to be impounded with a lag into the CDS rates of industry peers. That pattern appears to be more pronounced for negative than for positive earnings surprises. The lag in the response to earnings surprises is higher among firms of the financial, cyclical consumer and energy sectors, and almost non-existent for firms of the sectors of technology and utilities. Attention costs and market frictions seem to fuel the pattern of under-reaction of CDS spreads to these earnings announcements.ABSTRACTThis paper examines the way common-wide information is disseminated in credit default swap (CDS) markets. I find strong supporting evidence that earnings announcements of CDS references with greater liquidity and higher credit risk help in predicting the subsequent CDS spread movements of their industry peers. This is consistent with the notion that the earnings announcements of certain firms may contain valuable market- and industry-wide information, which may be utilised afterwards to appraise the financial situation and the creditworthiness of industry peers, thereby influencing their CDS rates. Another major finding is that this common-wide information seems to be impounded with a lag into the CDS rates of industry peers. That pattern appears to be more pronounced for negative than for positive earnings surprises. The lag in the response to earnings surprises is higher among firms of the financial, cyclical consumer and energy sectors, and almost non-existent for firms of the sectors of techno...

Do stress tests matter? A study on the impact of the disclosure of stress test results on European financial stocks and CDS markets

During the recent sovereign debt crisis, the European Banking Authority conducted two stress tests on European banks in order to gauge their capital needs, core Tier-1 ratios and ratios of resilience to adverse shocks. We assess the informational content of the disclosure of the stress test outcomes. We conclude that the stress tests conveyed new information and that the outcomes were not anticipated by the stock market but were partially anticipated by the credit default swap (CDS) market. However, while the stock market reacted to the disclosure of the stress test outcomes, in the CDS market there is some evidence of a ‘reverse’ reaction. Moreover, the publication of the outcomes of the stress tests had a stronger impact on the stock prices of riskier financial institutions. A similar pattern is evident in the CDS market, albeit narrowed to one of the stress tests and amid the financial institutions with higher perceived credit risk.

Earnings surprises and the response of CDS markets

Purpose This paper aims to investigate the informational content of earnings surprises and accounting information in credit default swap (CDS) markets. Design/methodology/approach This paper analyzes a sample of 444 US firms and 6,907 earnings announcements. By means of parametric and non-parametric event study analysis, the paper assesses the informational value and the timeliness in the assimilation of earnings surprises by CDS rates. Findings This paper shows that earnings surprises contain material information and that CDS rates are affected by the disclosure of obligors’ financial statements. There is also supporting evidence that positive and negative surprises induce asymmetric reactions on CDS rates, especially after accounting for the credit risk of the obligor and the liquidity of the CDS contract. Finally, and perhaps the most interesting conclusion of the study, there is evidence that earnings disclosed during unstable periods lack informational value, in opposition to normal periods. Originality/value As compared with similar studies, this paper presents three novel contributions. The first concerns the use of non-parametric analysis in parallel with parametric tests to achieve robust conclusions. The second novel contribution resides in assessing whether the liquidity of the CDS contracts affects the information value of earnings surprises or the timeliness at which the information is assimilated into CDS rates. Finally, this paper also contributes to improve our understanding on the relationship between the business cycle and the informativeness of accounting information.

Did informed order flow move to multilateral trading facilities? Evidence for some Eurozone countries

ABSTRACT This paper investigates the effects of the fragmentation of European stock markets after MiFID application in 2007. Specifically, we discuss whether the process of fragmentation elicited a flight of informed trading from the primary stock exchanges to the incoming multilateral trading facilities (MTFs). Our sample covers 438 stocks traded on six important markets of the Eurozone and the period ranging from 2010 to 2015. Our findings demonstrate that, on average, primary exchanges still drive the process of price formation. However, MTF platforms have been gradually expanding their influence over the price discovery process of some of the stocks so that for a non-negligible minority of them, MTFs already lead the price discovery.This paper investigates the effects of the fragmentation of European stock markets after MiFID application in 2007. Specifically, we discuss whether the process of fragmentation elicited a flight o...