To Change or Not to Change? The CDS Market Response of Firms on Credit Watch

45 Pages Posted: 5 Apr 2016 Last revised: 21 Jan 2020

See all articles by Florian Kiesel

Florian Kiesel

Free University of Bolzano-Bozen

Sascha Kolaric

University of Edinburgh Business School; Technical University of Darmstadt

Lars Norden

Getulio Vargas Foundation (FGV) - Brazilian School of Public and Business Administration (EBAPE); Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças

Dirk Schiereck

Technical University of Darmstadt

Date Written: January 21, 2020

Abstract

CDS spreads contain information about expected credit risk, but how accurate is this information when uncertainty about credit risk arises? We document that CDS spreads of firms on negative credit watch (review for downgrade) change systematically into the direction implied by the ex-ante uncertain review outcomes: they widen before reviews concluded with downgrades and tighten before reviews concluded with confirmations. Moreover, CDS spreads widen before deteriorations of corporate credit risk such as leverage, interest rate coverage and Altman Z-score that occur over the review period. Importantly, we do not find similar effects for firms’ stock returns. The evidence is novel and suggests that the CDS market not only reflects the increase in uncertainty but also accurate forward-looking information about the outcomes of the uncertainty-inducing events.

Keywords: Credit default swaps, uncertainty, 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, To Change or Not to Change? The CDS Market Response of Firms on Credit Watch (January 21, 2020). Available at SSRN: https://ssrn.com/abstract=2756900 or http://dx.doi.org/10.2139/ssrn.2756900

Florian Kiesel (Contact Author)

Free University of Bolzano-Bozen ( email )

Piazza Universita 1
Bolzano, 39100
Italy

Sascha Kolaric

University of Edinburgh Business School ( email )

29 Buccleuch Place
Edinburgh, EH8 9JS
United Kingdom

Technical University of Darmstadt ( email )

Hochschulstrasse 1
Darmstadt, 64289
Germany

HOME PAGE: http://www.cofi.wi.tu-darmstadt.de/team_cofi/lehrbeauftragte_2/sascha_kolaric/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

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil

Dirk Schiereck

Technical University of Darmstadt ( email )

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

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