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In Rememberance: World Trade Center (WTC)

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Insider Trading in Credit Derivatives

by Viral V. Acharya of the London Business School, and
Timothy C. Johnson of the London Business School

September 2005

Abstract: Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we report evidence of significant incremental information revelation in the credit default swap (CDS) market under circumstances consistent with the use of non-public information by informed banks. Specifically, the information revelation occurs only for negative credit news and for entities that subsequently experience adverse shocks. Moreover the degree of advance information revelation increases with the number of banks that have lending/monitoring relations with a given firm, and this effect is robust to controls for non-informational trade. We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true.

JEL Classification: G12, G13, G14, G20, D8.

Keywords: adverse selection, default, bank relationship, credit default swaps, asset pricing.

Published in: Journal of Financial Economics, Vol. 84, No. 1, (April 2007), pp. 110-141.

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