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Value Investing in Credit Markets

67 Pages Posted: 4 Apr 2011 Last revised: 16 Oct 2012

Maria M. Correia

London School of Economics and Political Science

Scott A. Richardson

AQR Capital Management, LLC; London Business School

A. Irem Tuna

London Business School

Date Written: March 31, 2011

Abstract

We outline a parsimonious empirical model to assess the relative usefulness of accounting and equity market based information to explain corporate credit spreads. The primary determinant of corporate credit spreads is the physical default probability. We compare existing accounting-based and market-based models to forecast default, and find that a modified structural model with accounting and market inputs is best able to forecast default and explain cross-sectional variation in credit spreads. We then assess whether the credit market completely incorporates this default information into credit spreads. Interestingly, we find that credit spreads reflect information about forecasted default rates with a significant lag. This evidence is suggestive of a role for value investing in credit markets.

Keywords: credit markets, CDS, bonds, default prediction

JEL Classification: G12, G14, M41

Suggested Citation

Correia, Maria M. and Richardson, Scott A. and Tuna, A. Irem, Value Investing in Credit Markets (March 31, 2011). Review of Accounting Studies, Vol. 17, No. 3, 2012. Available at SSRN: https://ssrn.com/abstract=1800212 or http://dx.doi.org/10.2139/ssrn.1800212

Maria M. Correia

London School of Economics and Political Science ( email )

Houghton St
London, London WC2A 2AE
United Kingdom

Scott Anthony Richardson (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Ayse Irem Tuna

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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