Why is Accounting Information Important to Bondholders?
Posted: 9 Jan 2017
Date Written: January 5, 2017
We investigate the relevance of accounting information for bondholders. Our results imply that the credit markets access the firm’s default information through accounting signals. This information is reflected through cash flow (CF) and discount rate (DR) news. Specifically, the sensitivity of bond prices to the news increases, as firms get closer to default due to increasing firm-level credit risk or because aggregate credit conditions worsen. However, the latter is more important. Thus, the importance of a given accounting signal depends on: 1) the mix of CF and DR news it reflects; 2) the firm’s proximity to default; and 3) the aggregate credit conditions. We incorporate these insights into a dynamic trading strategy that earns significant risk-adjusted returns. These results are robust after controlling for liquidity and transaction costs.
JEL Classification: G11; G12
Suggested Citation: Suggested Citation