Credit Default Swaps and Firm Value
Journal of Financial and Quantitative Analysis (JFQA), Forthcoming
Posted: 31 May 2017 Last revised: 20 Dec 2017
Date Written: April 25, 2017
This paper provides evidence that firm value declines when credit default swaps (CDS) are initiated, and that the effect is greater when CDS trading activity is higher. This decline, which arises from an increase in the cost of capital as opposed to a decrease in free cash flows, traces to a deterioration in the firm’s credit quality and stock liquidity. Firm value declines less when CDS trading is likely to produce incremental information, suggesting that CDS trading has informational benefits for firm value. However, the evidence does not indicate that firm value increases because CDS availability facilitates investments.
Keywords: Credit default swaps (CDSs); Firm value; Cost of capital; Cost of debt; Cost of equity; Financial distress; Empty creditor hypothesis
JEL Classification: G32; G33; G14
Suggested Citation: Suggested Citation