How Do Corporate Factors Affect Price Discovery Process Between Equity and Credit Markets?

ABSTRACT We conduct price discovery analysis to investigate the lead–lag relationship between equity and CDS markets within a corporate finance framework. Based on a sample of 89 firms covering investment‐grade and high‐yield firms, we detect stationarity and cointegration within a panel framework associated with nine corporate financial characteristic factors. With an expectation maximisation Kalman filter applied to deal with non‐synchronicity and microstructure noise in 1‐min data, we verify its practicability in addressing the issue of missing data in a high‐frequency modelling setting. We demonstrate that the price discovery process is more credit market driven when a company's credit risk increases, which is significantly more prominent for small‐sized firms with highly volatile equity prices and increasing default probability.