Price discovery process in the emerging sovereign CDS and equity markets

We model two regimes using threshold cointegration and threshold vector error correction model for sovereign CDS and equity markets of thirteen emerging markets. We document evidence of momentum in cointegration relationships in CDS and equity markets of all countries. We find that positive and negative divergences adjust to equilibrium relationship at different speeds and magnitudes depending on the regime. Moreover, the short and long run adjustment process of each asset is nonlinear and regime dependent. Linear modeling may ignore the differential reaction of investors and policy makers and the time-varying market conditions under which economic and investment decisions take place. © 2014.