Price discovery process in the emerging sovereign CDS and equity markets Geoffrey M. Ngene a,1 , M. Kabir Hassan b,2 , Nafis Alam c,3 a Stetson School of Business and Economics, Mercer University, 1400 Coleman Avenue, Macon, GA 31207, United States b Department of Economics and Finance, University of New Orleans, 2000 lakeshore Dr, New Orleans, LA 70148, United States c Nottingham University Business School, The University of Nottingham Malaysia campus, Jalan Broga, Semenyih 43500, Selangor, Malaysia article info abstract Article history: Received 6 August 2013 Received in revised form 8 August 2014 Accepted 12 August 2014 Available online 20 August 2014 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 Published by Elsevier B.V. JEL classification: C13 E43 G15 Keywords: Price discovery CDS Equity Emerging markets 1. Introduction Extant literature surmises that cointegration and price discovery mechanisms are both constant and continuous under linear modeling. This is only realistic if homogeneous agents dominate financial markets. However, a large body of finance literature lucidly document that heterogeneous agents dominate financial markets. Hommes and Florian (2009), using the seminal works of Simon (1991) and Rubinstein (1998), argue that financial markets are complex adaptive systems, dominated by incessantly interacting heterogeneous agents with “bounded rationality”. The heterogeneous agents thus have limited information, cognitive abilities Emerging Markets Review 21 (2014) 117–132 E-mail addresses: Ngene_gm@mercer.edu (G.M. Ngene), mhassan@uno.edu (M. Kabir Hassan), nafis.alam@nottingham.edu.my (N. Alam). 1 Tel.: +1 478 301 2719. 2 Tel.: +1 504 280 6163. 3 Tel.: +1 6016 257 5486. http://dx.doi.org/10.1016/j.ememar.2014.08.004 1566-0141/© 2014 Published by Elsevier B.V. Contents lists available at ScienceDirect Emerging Markets Review journal homepage: www.elsevier.com/locate/emr