Does the CDS market anticipate future changes in firm risk?
46 Pages Posted: 5 Apr 2016 Last revised: 26 Sep 2018
Date Written: September 20, 2018
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: Suggested Citation