The Impact of Earnings on the Pricing of Credit Default Swaps

37 Pages Posted: 8 Oct 2008

See all articles by Jeffrey L. Callen

Jeffrey L. Callen

University of Toronto - Rotman School of Management

Joshua Livnat

New York University; Prudential Financial - Quantitative Management Associates

Dan Segal

Interdisciplinary Center (IDC) Herzliyah

Date Written: December 2006

Abstract

This study evaluates the impact of earnings on firm credit risk as captured by CreditDefault Swaps (CDS). We find that earnings (changes) are negatively correlated withone-year swap premia (changes) after controlling for equity returns but not with longer term premia (changes). We also find that earnings surprises are significantly correlated with one-year CDS premia changes in the short window surrounding preliminaryearnings dates and that absolute earnings surprises are significantly correlated withabsolute one-year CDS premia changes in the short window surrounding SEC filingdates. These results suggest that high earnings convey favorable information about the short-term default risk of firms but not about the long term default risk. We furtherdocument that accruals/cash flow information conveyed by SEC filings providesinformation about long-term credit risk. Furthermore, the empirical results are consistent with structural and hybrid model-driven implications of CDS pricing.

Suggested Citation

Callen, Jeffrey L. and Livnat, Joshua and Segal, Dan, The Impact of Earnings on the Pricing of Credit Default Swaps (December 2006). NYU Working Paper No. JOSHUA LIVNAT-05. Available at SSRN: https://ssrn.com/abstract=1280739

Jeffrey L. Callen (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-946-5641 (Phone)
416-971-3048 (Fax)

Joshua Livnat

New York University ( email )

44 West 4th Street, Suite 10-76
Stern School of Business
New York, NY 10012-1118
United States
212-998-0022 (Phone)
212-995-4004 (Fax)

Prudential Financial - Quantitative Management Associates ( email )

2 Gateway Center
6th Fl.
Newark, NJ 07102
United States

Dan Segal

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

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