Value Investing in Credit Markets
Maria M. Correia
London School of Economics and Political Science
Scott A. Richardson
AQR Capital Management, LLC; London Business School
A. Irem Tuna
London Business School
March 31, 2011
Review of Accounting Studies, Vol. 17, No. 3, 2012
We outline a parsimonious empirical model to assess the relative usefulness of accounting and equity market based information to explain corporate credit spreads. The primary determinant of corporate credit spreads is the physical default probability. We compare existing accounting-based and market-based models to forecast default, and find that a modified structural model with accounting and market inputs is best able to forecast default and explain cross-sectional variation in credit spreads. We then assess whether the credit market completely incorporates this default information into credit spreads. Interestingly, we find that credit spreads reflect information about forecasted default rates with a significant lag. This evidence is suggestive of a role for value investing in credit markets.
Number of Pages in PDF File: 67
Keywords: credit markets, CDS, bonds, default prediction
JEL Classification: G12, G14, M41
Date posted: April 4, 2011 ; Last revised: October 16, 2012
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