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Firm Policies and the Cross-Section of CDS Spreads

62 Pages Posted: 31 Jul 2012 Last revised: 11 Mar 2014

Andrea Gamba

University of Warwick - Finance Group

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: August 7, 2013

Abstract

We solve the credit spread puzzle with a structural model of firm’s policies that endogenously replicates the empirical cross-section of credit spreads. Structural estimation of the model's parameters reveals that the model cannot be rejected by the data, and that endogenous investment decisions are major determinants of CDS spreads. We also verify that controlling for financial leverage, CDS spreads are positively related to operating leverage, and negatively related to growth opportunities. Consistent with the idea that growth options reduce credit risk, investments are negatively correlated with changes in CDS spreads.

Keywords: CDS, leverage, credit risk, default

JEL Classification: G12, G32

Suggested Citation

Gamba, Andrea and Saretto, Alessio, Firm Policies and the Cross-Section of CDS Spreads (August 7, 2013). Available at SSRN: https://ssrn.com/abstract=2120904 or http://dx.doi.org/10.2139/ssrn.2120904

Andrea Gamba

University of Warwick - Finance Group ( email )

Scarman Road
Coventry, CV4 7AL
Great Britain
+44 (0)24 765 24 542 (Phone)
+44 (0)24 765 23 779 (Fax)

Alessio Saretto (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

800 Campbell Road
SM 31
Richardson, TX 75080
United States
972-883-5907 (Phone)

HOME PAGE: http://www.utdallas.edu/~axs125732

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