Credit default swap (CDS) markets and other credit derivative markets experienced a significant increase in importance over the last two decades. These kind of financial instruments are usually traded in the over-the-counter (OTC, henceforth) platforms where the major players are institutional investors, such as banks, investment firms, hedge funds and insurance companies. According to Brunnermeier et al. (2013), the gross notional amount of the EU CDS market reached 4.28 trillion EUR in 2012, distributed by hedge funds (40%), asset managers (33%), banks (18%) and insurance companies or pension plans (10%).
The liquidity is provided by a small number of dealers (Arakelyan et al.,2012), and the lack of competition in CDS markets gives rise to dealer market power with significant price impact (Gunduz, Nasev and Traap, 2013). As a matter of a fact, Brunnermeier et al. (2013) denoted these supersized market makers as “super-spreaders”. The formers emphasized the fact that protection selling was concentrated around fifteen players – mostly banks and asset managers. Mengle (2010) provides similar results and document that only 18% of the players are overall CDS net sellers, and that the top ten “super-spreaders” represent more than 73% of the total gross sales.
In fact, large financial institutions are amongst the major players of these markets. Because they provide different kinds of financial services to other firms, they own a large amount of private information of their costumers’ activity. Acharya and Johnson (2007) among others, document the presence of information flow from the CDS market to the equity market, especially when the reference firm has a large number of bank relationships and during times of financial stress (i.e. credit rating downgrade). Indeed, the authors argue that major financial institutions act simultaneously as players in the CDS markets and as lenders of firms and use their private information about the financial situation of firms in their trading and quoting activity.
In the same line, Norden (2011) argues that major participants of the CDS markets are large commercial banks, whose have preferential access to private information about the financial condition of the names of CDS contracts. Ivashina and Sun (2011) argue that as lenders, institutional investors routinely collect private information about borrowers. Concurrently, most of these investors also trade in public securities. The authors document that the institutional participants in loan renegotiations subsequently trade in the stock of the same company and outperform trades by other investors and trades in other stocks by approximately 4.4% in annualized terms. A similar conclusion derives from Bushman, Smith and Wittenberg-Moerman (2008) analysis regarding the association of the performance of secondary syndicated loan markets and equity markets for firms with syndicated loans outstanding. Using measures of intra-period timeliness to measure the speed of...