Does the CDS Market Anticipate Changes in Firm Risk?
47 Pages Posted: 5 Apr 2016 Last revised: 1 Mar 2019
Date Written: October 22, 2018
We investigate whether the CDS market anticipates changes in firm risk, exploiting the uncertainty about the outcomes of credit rating reviews (rating changes or confirmations). We find that CDS spreads of firms under review for downgrade move systematically into the direction implied by the review outcome: they widen before downgrades and tighten before confirmations. Moreover, CDS spreads start widening before rating reviews that result 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 increase default risk.
Keywords: Credit default swaps, credit risk, informational efficiency, credit ratings, rating reviews
JEL Classification: G14, G24, G32, G33
Suggested Citation: Suggested Citation