Are Option and CDS Markets Integrated?

An increasing number of studies extract credit spreads using equity options data. This inference relies on the assumption that option and credit markets are integrated. I empirically test this assumption using firm level option implied credit spreads (IS) and CDS spreads. While the IS and CDS spreads are cointegrated, suggesting that they converge to an equilibrium relation in the long run, I find significant short-lived price discrepancies. These price discrepancies are closely associated with variables related to limits to arbitrage, such as illiquidity, idiosyncratic risk, institutional ownership, and analyst coverage, as well as the health of financial intermediaries. I provide a stylized asset pricing framework with an intermediary constraint, which can rationalize the salient features of the empirical evidence