Credit Default Swap Spreads as Viable Substitutes for Credit Ratings

40 Pages Posted: 27 Aug 2010 Last revised: 3 Sep 2010

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

Joel F. Houston

University of Florida - Department of Finance, Insurance and Real Estate

Frank Partnoy

University of San Diego School of Law

Date Written: August 26, 2010

Abstract

We evaluate the viability of credit default swaps (CDS) spreads as substitutes for credit ratings. We focus on CDS spreads based on the obligations of financial institutions, particularly fifteen large financial institutions that were prominently involved in the recent financial crisis. Our data, from 2006-09, show that CDS spreads incorporate new information about as quickly as equity prices, and significantly more quickly than credit ratings. Although CDS spreads did not identify accumulating risk exposures before 2007, they quickly reflected disclosures and developments beginning in summer 2007 at the latest. Thus, CDS spreads are a promising market-based tool for regulatory and private purposes, and they may serve as a viable substitute for credit ratings.

Keywords: credit ratings, credit default swaps, finance, structured finance, event studies

JEL Classification: C10, D40, D43, G12, G18, G28, G38, K20, K22, K23, L10, L40

Suggested Citation

Flannery , Mark J. and Houston, Joel F. and Partnoy, Frank, Credit Default Swap Spreads as Viable Substitutes for Credit Ratings (August 26, 2010). University of Pennsylvania Law Review, Vol. 158, 2010; San Diego Legal Studies Paper No. 10-031. Available at SSRN: https://ssrn.com/abstract=1666350

Mark Jeffrey Flannery

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-3184 (Phone)
352-392-0103 (Fax)

Joel F. Houston

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Frank Partnoy (Contact Author)

University of San Diego School of Law ( email )

5998 Alcala Park
San Diego, CA 92110-2492
United States
619-260-2352 (Phone)
619-260-4180 (Fax)

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