The Impact of Earnings on the Pricing of Credit Default Swaps

Posted: 3 Dec 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

Multiple version iconThere are 2 versions of this paper

Date Written: December 2, 2008

Abstract

This study evaluates the impact of earnings on credit risk in the Credit Default Swap (CDS) market using levels, changes, and event study analyses. We find that earnings (cash flows, accruals) of reference firms are negatively and significantly correlated with the level of CDS premia, consistent with earnings (cash flows, accruals) conveying information about default risk. Based on the changes analysis, a 1 percent increase in ROA decreases CDS rates significantly by about 5 percent. We also find that (i) CDS premia are more highly correlated with below-median earnings than with above-median earnings and (ii) CDS premia are more highly correlated with earnings of low rated firms than with earnings of high rated firms. Evidence indicates further that short-window earnings surprises are negatively and significantly correlated with CDS premia changes in the three-day window surrounding the preliminary earnings announcement, although the impact is concentrated in the shorter maturities.

Keywords: Credit Default Swaps, Earnings, Default Risk, Cash Flows, Accruals

JEL Classification: M41, G13, G20, G32

Suggested Citation

Callen, Jeffrey L. and Livnat, Joshua and Segal, Dan, The Impact of Earnings on the Pricing of Credit Default Swaps (December 2, 2008). Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1310363

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 )

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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 )

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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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