Capital Structure, Derivatives and Equity Market Quality

We find that firms with listed equity options have more liquid equity and more efficient stock prices. By contrast, firms with traded CDS contracts have less liquid equity and less efficient stock prices, especially when these firms or their capital structures are complex (i.e., hard to value). The impact of having a publicly traded bond market is somewhat mixed; however, we observe a signicantly negative role for all trading activity in the related markets (i.e., in both bonds and options) for efficiency and liquidity. Taken together, these results imply an overall negative effect of related markets when those markets are tied to debt in a firm's capital structure.