Credit Default Swap Spread Changes Research Articles

Corporate credit default swap systematic factors

AbstractWe examine a comprehensive set of systematic and firm‐specific determinants of the credit default swap (CDS), using a two‐step approach to explore the factor's effect on CDS spread changes. We show that systematic factors are important and account for the most changes in the CDS spreads (with average of 35%), while firm‐specific factors are limited (with of 5% in panel regression) with only 4 out of 28 firm‐specific factors being significant. It implies that the systematic factors are overlooked in the literature, and they can provide many implications for practitioners in CDS pricing and the firm's credit risk management.

Uncertain tone, asset volatility and credit default swap spreads

We examine the relationship between uncertain linguistic tone and credit default swap (CDS) spreads. Using an event study approach, we first show that uncertain linguistic tone in 10-Q/K filings is positively associated with CDS spread changes incremental to positive and negative tone and incremental to the response implied by equity market reactions to the same information. We further demonstrate that the relationship of uncertain tone to CDS spreads manifests largely through its impact on asset volatility. We show that this effect is driven by firms with high leverage and is stronger among firms with shorter relative to longer maturities. Our findings contribute to growing research into credit market reactions to non-quantitative information by demonstrating a positive relationship between credit market responses and uncertainty disclosure language, and that this relationship is mediated by investors’ implied asset volatility estimates.

Determinants of credit default swap spread changes: The sell-side perspective

This study revisits the credit spread puzzle using credit default swap spread changes between 2002 and 2020. We find that credit-related structural variables account for only 13.8% of the variation in credit default swap spread changes. There exists a single dominant common component that explains 49.8% of the regression residuals. Sell-side risk-bearing constraints are closely related to the unknown common component and significantly improve the explanatory power of credit default swap spread changes, particularly the commonality between them.

Stock buybacks and credit default swap spread changes

The authors investigate whether the effects of stock buyback announcements on credit default swap (CDS) spread changes for US firms depend on macroeconomic conditions. The authors find that abnormal CDS spreads increase for small-sized firms announced to repurchase a higher share ratio during the normal period. In contrast, abnormal CDS spreads decrease for big-sized firms regardless of the magnitude of the repurchase ratio during the crisis period. The results of this study suggest that the wealth transfer effect dominates the signaling effect for small-sized firms with higher target ratios during the normal period. In contrast, the signaling effect is stronger for bondholders of big-sized firms during the crisis period.

The Credit Risk of Sustainable Firms during the Pandemic

This study investigates how the credit risk of more sustainability-oriented firms changes when national governments intervene in their economies to counterbalance the COVID-19 pandemic. For this reason, we examine how the credit default swap spread changes on a database of all listed firms—for which a credit default swaps (CDS) contract is available—in Europe and the United Kingdom during the whole year of 2020. We find that when national governments intervene in the local economies, the CDS spreads for these firms decrease more than for other firms. Furthermore, the CDS spread changes are more sensitive to those policies aimed at supporting household and business income during the pandemic rather than those policies related to stay-at-home measures and investments in healthcare. Our results corroborate previous theories linking firm sustainability, equity and credit risk.

SOVEREIGN CREDIT DEFAULT SWAP (CDS) SPREADS CHANGES IN VARIOUS ECONOMIC CONJUNCTURES: EVIDENCE FROM TURKEY BY MACHINE LEARNING ALGORITHMS

The study aims to define the sources of Turkey’s sovereign CDS spread changes to develop policies that stabilize CDS spreads since they have a volatile and increasing trend, especially in the last two years. In this context, monthly data of 13 factors related to international, macroeconomic, and market between 2011/1 and 2019/12 are used by dividing the dataset into three periods as the full period (2011-2019), the stability period (2011-2017), and the macroeconomic turbulent period (2018-2019) and performing 4 different machine learning algorithms. The empirical results prove that (i) Treasury bond interest rate should be lower than 8% in the stability period and gold prices should be lower than TL 5.500 in the macroeconomic turbulent period to have low-level CDS spreads; (ii) NPL volume has no significant effect on in any period examined; (iii) the significance of factors on sovereign CDS spreads vary over the periods.

Investor behavior, stock returns and CDS spreads: evidence from foreign and domestic investors in Korea

PurposeThis study investigates the dynamic relationships among trading behaviors of different investor groups (foreigners, domestic institutions and domestic individuals), stock returns and sovereign CDS (Credit Default Swap) spreads in Korea.Design/methodology/approachWe employ the VAR (Vector autoregression) model to examine the dynamic relationships between CDS spread changes, stock returns and investors' behavior in the stock market.FindingsThe CDS spread change (stock return) declines (rises) in response to shocks to net foreign flows into the stock market on the same day. Foreigners buy stocks more intensely one day after an increase in the stock return, but they do not respond to CDS spread changes. Domestic individuals trade in the opposite direction of foreigners in response to shocks to both stock returns and CDS spread changes on the same day. Positive net stock purchases of domestic institutions (individuals) predict positive (negative) stock returns and negative (positive) CDS spread changes next day.Originality/valueThis study extends prior studies by examining how different investor groups' trading behaviors in the stock market are associated with not only the stock market but also a closely related market (CDS market). Prior empirical studies on the relation between the stock and CDS markets do not pay attention to possible heterogeneity in trading behavior across different types of investors in the stock market.

Contagion between liquid and illiquid assets during the financial crisis: evidence from the US credit derivative market

This study aims to investigate the existence of contagion between liquid and illiquid assets in the credit default swap (CDS) market around the recent financial crisis. The authors perform analyses based on vector autoregression model and the dynamic conditional correlation model. The estimation of vector autoregression models reveals that changes in liquid CDS (LCDS) spreads lead to changes in illiquid CDS spreads at least one week ahead during the financial crisis period, whereas the leading direction is reversed during the post-crisis period. Moreover, the results are robust after controlling for structural variables which are proven as determinants of CDS spreads and are empirically supported. This study interprets that information was incorporated first into the LCDSs because of the flight-to-liquidity during the recent crisis period but there is a default contagion effect by reflecting illiquidity-induced credit risk after the crisis. Finally, the dynamic conditional correlation analysis also confirms the main results.

Utilizing News Topics for Credit Risk Management: The Explanation of Bank CDS Spreads

ABSTRACT Monitoring the default risk of banks is highly relevant for companies when they enter into derivative contracts with banks to hedge risks. These contracts are subject to the counterparty risk of the bank defaulting. In credit risk management, market-based measures such as credit default swap (CDS) spreads are used to continuously assess the credit risk of counterparties. At the same time, CDS spreads are difficult to interpret and explain. We investigate which financial news topics are positively or negatively related to bank CDS spreads. Our findings indicate that especially negative news topics are significantly associated with changes in CDS spreads. These include not only financial aspects such as a decrease in dividends or revenue guidance but also non-financial topics such as sanctions and legal issues. Thereby, our understanding of which topics addressed in financial news are relevant for supporting decision-making in the context of credit risk management is improved.

Sovereign Credit Spread Spillovers in Asia

Sovereign credit default swap (CDS) spreads exhibit strong co-movements across Asian countries and regions, including both emerging and developed economies. After controlling for global impacts, we examine the regional lead-lag relationships among changes in ten Asian sovereign CDS spreads. We use the pairwise Granger causality test to find that lagged changes in Kazakhstan’s sovereign CDS spreads significantly predict changes in other Asian sovereign CDS spreads. By estimating the news-diffusion model, we find evidence that this predictive relationship may be explained by information diffusion. Furthermore, we find that lagged changes in Kazakhstan’s CDS spreads have significant out-of-sample predictive power for other Asian economies, providing practical implications for sustainable investments and risk management.

Are Credit Markets Tone Deaf? Evidence from Credit Default Swaps

We examine the impact of abnormal uncertain tone on changes in credit default swap (CDS) spreads. Using an event study approach, we show that uncertain linguistic tone in 10-Q/K filings positively affects CDS spread changes. We further show that this effect is driven by firms with high leverage and is stronger among firms with shorter relative to longer maturities. We demonstrate that the effect of uncertain tone manifests into CDS spreads largely through its impact on asset volatility. Our findings are consistent with credit market participants linking uncertainty in disclosure language to firms' default risk through their asset volatility estimates.

Large EU banks’ capital and liquidity: Relationship and impact on credit default swap spreads

This paper explores the interrelations between bank capital and liquidity and their impact on the market probability of default. We employ an unbalanced panel of large European banks with listed credit default swap (CDS) contracts during the period 2005–2015, which allow us to consider the impact of the recent financial crisis. Our evidence suggests that bank capital and funding liquidity risk as defined in Basel III have an economically meaningful bidirectional relationship. However, the effect on CDS spread is ambiguous. While capital appears to have a relatively large impact on CDS spread changes, liquidity risk is priced only when it falls below the regulatory threshold.

The Co‐Movement of Credit Default Swap Spreads, Equity Returns and Volatility: Evidence from Asia‐Pacific Markets

AbstractWe provide a comprehensive analysis of the co‐movement of credit default swap (CDS), equity, and volatility markets in four Asia‐Pacific countries at firm and index level during the period 2007–2010. First, we examine lead–lag relationships between CDS spread changes, equity returns, and changes in volatility using a vector autoregressive model. At the firm level equity returns lead changes in CDS spreads and realized volatility. However, at the index level the intertemporal linkages between the three markets are less clear‐cut. Second, we apply the measures proposed by Diebold and Yilmaz (2014) to an analysis of volatility spillovers among the CDS, equities, and volatility asset classes. The results suggest that realized volatility (at firm level) and implied volatility (at index level) are the main transmitters of cross‐market volatility spillovers. Third, we analyze the impact of various structural factors and confirm the importance of realized volatility of equity returns as a determinant of CDS spreads.

Game changer? The impact of the VW emission-cheating scandal on the interrelation between large automakers’ equity and credit markets

This paper investigates the change in the securities market pricing behavior of 16 large, global automakers following disclosure of the Volkswagen (VW) emission-cheating scandal on September 18, 2015, when the EPA issued a notice of violation to VW, stating that VW had intentionally circumvented the US clean air rules for diesel automobile emissions. We contend that this event unblocked an informational cascade, in that much of the information was already known to outside parties, yet no significant market response occurred until the September 18 EPA notice. We also find a significant change in the evolution of equity and credit default swap (CDS) prices in the automobile industry consistent with more-informed trading in the equity market. A test of economic significance further supports this finding by showing a decrease in the profitability of a trading rule based on a predictive relation between CDS spread changes and lagged equity returns.

Debtholder Wealth Effects in Mergers and Acquisitions: Evidence from the CDS Market

This paper examines changes in acquirer and target companies’ Credit Default Swap (CDS) spreads as a proxy for default risk around official mergers and acquisitions (M&A) announce-ments. Related literature extensively documents wealth effects triggered by M&A from the shareholders’ perspective, but there is only a slight evidence on the wealth effects experienced by the transaction firms’ debtholders. Therefore, this study adds to the literature by exploring the impact of M&A announcements on CDS spreads empirically. A negative correlation between M&A and the development of the value of debt securities is increasingly being addressed as a central theme from the acquirer’s perspective. In contrast, the literature assumes that the target’s debtholders earn positive wealth effects from acquisition. Hence, we detect acquiring and target firms’ abnormal changes in CDS spreads between 2004 and 2016 as a basis for regression analyses. In this regard, we take deal characteristics as well as other determinants that could have influenced respective company’s credit risk into account. Our evidence suggests that M&A, on average, increase the acquiring firms’ default risk, but tend to improve the target firms’ risk position.

Measuring Sovereign Risk: Are CDS Spreads Better than Sovereign Credit Ratings?

AbstractUsing data for 54 countries over a 12‐year period, we find that the variation in average sovereign ratings in a given year can be explained by average credit default swap (CDS) spreads over the previous three years. In a horse race between CDS spreads and sovereign ratings, we find that CDS spread changes can predict sovereign events, while rating changes cannot. The predictability of CDS spreads is greater when there is disagreement between Moody's and the S&P for a country's rating.

Short‐selling and credit default swap spreads—Where do informed traders trade?

During the global financial crisis, short‐selling and credit default swaps (CDS) gained notoriety as indicators of financial collapse. This paper extends the literature by examining the relationship between short‐selling and CDS spreads. Results indicate that lagged short‐selling metrics forecast changes in CDS spreads; short‐selling is found to have a positive relationship with CDS spreads. These results are robust to various controls including the supply of stock for short‐selling, changes in CDS spreads, cross‐sectional controls for fixed effects, sub‐group analysis by industry sector, and the use of contemporaneous explanatory variables. This suggests that informed traders prefer to short‐sell the underlying stocks.

WITHDRAWN: S&P 500 Index evisions and credit spreads

AbstractWe investigate the impact of S&P 500 Index revisions on credit spreads from 2001 to 2014. Additions have a significant negative impact on credit default swap (CDS) spreads both during the financial crisis period and for speculative grade firms, but deletions show no significant CDS spread changes. After excluding the effect of market integration between the stock and CDS markets, we find that S&P 500 Index inclusion conveys no unique information beyond that due to market integration except during the financial crisis. Furthermore, CDS trading liquidity does not improve after S&P 500 Index inclusion.

Macroeconomic Conditions and Credit Default Swap Spread Changes

This study investigates the importance of the business cycle in explaining credit default swap spread changes by utilizing ex ante proxies. It uses portfolio regression and finds the structural variables, including the business cycle, explain approximately 65% of the spread differences. Furthermore, the business cycle variable enhances explanatory power more during the pre‐ and post‐crisis periods than during the crisis period and shows greater improvement for investment‐grade than for non‐investment‐grade firms. These results suggest that macroeconomic conditions play a critical role when the underlying asset value is likely to have greater distance from the default barrier. © 2017 Wiley Periodicals, Inc. Jrl Fut Mark 37:766–802, 2017

What Drives the Commonality between Credit Default Swap Spread Changes?

This paper documents an increase in the comovement between credit default swap (CDS) spread changes during the 2007–2009 crisis and investigates the source of that increase. One possible explanation is that comovement increased because fundamental values became more correlated. However, I find that changes in fundamentals account for only 23% of the increase in covariance. The remaining increase is attributed to changes in liquidity and the market price of default risk. In contrast, counterparty risk played an insignificant role. Although both contributed, the increase in covariance was driven more by variation in exposures than factor variance–covariance.