Does the CDS market anticipate future changes in firm risk?

46 Pages Posted: 5 Apr 2016 Last revised: 26 Sep 2018

Florian Kiesel

Darmstadt University of Technology

Sascha Kolaric

Technische Universität Darmstadt

Lars Norden

Getulio Vargas Foundation (FGV) - Brazilian School of Public and Business Administration (EBAPE)

Dirk Schiereck

Darmstadt University of Technology

Date Written: September 20, 2018

Abstract

We investigate whether CDS spreads contain information about future changes in firm risk. Using 1,520 credit rating reviews from 2004-2015, we document that CDS spreads of firms under review for downgrade change systematically into the direction implied by the review outcome: they widen before downgrades and tighten before confirmations. CDS spreads also widen before rating reviews resulting in downgrades and before deteriorations of firms’ key financial ratios. We do not find similar effects for firms’ stock returns. The evidence suggests that the CDS market anticipates firms’ financial decisions that lead to future increases in default risk.

Keywords: Credit default swaps, credit risk, informational efficiency, credit ratings, rating reviews

JEL Classification: G14, G24, G32, G33

Suggested Citation

Kiesel, Florian and Kolaric, Sascha and Norden, Lars and Schiereck, Dirk, Does the CDS market anticipate future changes in firm risk? (September 20, 2018). Available at SSRN: https://ssrn.com/abstract=2756900 or http://dx.doi.org/10.2139/ssrn.2756900

Florian Kiesel (Contact Author)

Darmstadt University of Technology ( email )

Hochschulstrasse 1
Darmstadt, 64289
Germany

Sascha Kolaric

Technische Universität Darmstadt ( email )

Hochschulstrasse 1
Darmstadt, 64289
Germany

HOME PAGE: http://www.cofi.wi.tu-darmstadt.de/team_cofi/wimi_cofi/kolaric_cofi/index.en.jsp

Lars Norden

Getulio Vargas Foundation (FGV) - Brazilian School of Public and Business Administration (EBAPE) ( email )

Rua Jornalista Orlando Dantas 30
Rio de Janeiro, 22231-010
Brazil
+552130832431 (Phone)

HOME PAGE: http://www.larsnorden.de

Dirk Schiereck

Darmstadt University of Technology ( email )

Universitaets- und Landesbibliothek Darmstadt
Magdalenenstrasse 8
Darmstadt, Hesse D-64289
Germany

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