43 Pages Posted: 7 Jan 2011 Last revised: 18 Jun 2011
Date Written: March 1, 2011
The slope of a firm's term structure of credit default swap (CDS) spreads (five-year spread minus one-year spread) negatively predicts future stock returns. Stocks with low CDS slope on average outperform stocks with high CDS slope by over 1% each month for the next six months. Our result can not be explained by standard risk factors, stock characteristics, default risk measures or changes in CDS spreads. We find that CDS slope positively predicts future changes in CDS spreads, but the information content of CDS slope only slowly gets incorporated into stock price. CDS slope predicts return mainly for stocks facing high arbitrage costs.
Keywords: credit default swap, term structure, cross-section of stock return, default risk premium, slow information diffusion
JEL Classification: G12
Suggested Citation: Suggested Citation
Han, Bing and Zhou, Yi, Term Structure of Credit Default Swap Spreads and Cross-Section of Stock Returns (March 1, 2011). McCombs Research Paper Series No. FIN-01-11; AFA 2012 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1735162 or http://dx.doi.org/10.2139/ssrn.1735162