Pandemic Exposure, Credit Market Reactions, and Corporate Default Risk

Abstract

This paper provides an innovative theoretical model and empirical evidence for how firm-level pandemic exposure, as an informational shock, increases a firm's credit spread and default risk. We find a positive relationship between pandemic exposure and single-name CDS spreads, and this empirical relationship remains under robustness checks and after controlling for endogeneity. Furthermore, we find that this effect of pandemic risk is more pronounced for firms with higher leverage. COVID-19 exposure has a much more significant economic impact on credit spread than the past pandemics. We also find firm-level pandemic risk reduces CDS spread slope and increases credit spread volatility which indicates that pandemic risk tends to manifests as as short-term shock that results in short term credit spreads trading higher relative to longer term credit spreads and more uncertainty around credit status.