Firm Policies and the Cross-Section of CDS Spreads
University of Warwick - Finance Group
University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics
August 7, 2013
We solve the credit spread puzzle with a structural model of firm’s policies that endogenously replicates the empirical cross-section of credit spreads. Structural estimation of the model's parameters reveals that the model cannot be rejected by the data, and that endogenous investment decisions are major determinants of CDS spreads. We also verify that controlling for financial leverage, CDS spreads are positively related to operating leverage, and negatively related to growth opportunities. Consistent with the idea that growth options reduce credit risk, investments are negatively correlated with changes in CDS spreads.
Number of Pages in PDF File: 62
Keywords: CDS, leverage, credit risk, default
JEL Classification: G12, G32working papers series
Date posted: July 31, 2012 ; Last revised: March 11, 2014
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