When do CDS Spreads Lead? Rating Events, Private Entities, and Firm-specific Information Flows

81 Pages Posted: 31 Mar 2017 Last revised: 1 Jun 2018

See all articles by Jongsub Lee

Jongsub Lee

University of Florida - Warrington College of Business Administration

Andy Naranjo

University of Florida - Warrington College of Business Administration

Guner Velioglu

University of Florida - Warrington College of Business Administration

Date Written: November 16, 2017

Abstract

We find that CDS spreads contribute significantly to price discovery in financial markets when firm-specific credit information is prominent. Using 3,470 S&P rating notch and watch changes for U.S. public and private entities from 2001-2013, we show that CDS prices contain unique firm credit risk information that is not captured by the prices of other related securities such as stock and bonds of the same firm. Credit information unidirectionally flows from CDS to bonds, particularly for private entities whose stocks are not concurrently trading in markets. We further find that CDS returns significantly predict stock returns, particularly their idiosyncratic components.

Keywords: CDS versus stocks and bonds, credit ratings, firm-specific credit information flow, lead-lag relations, private firms

JEL Classification: D80, G14, G20, G32

Suggested Citation

Lee, Jongsub and Naranjo, Andy and Velioglu, Guner, When do CDS Spreads Lead? Rating Events, Private Entities, and Firm-specific Information Flows (November 16, 2017). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2933052 or http://dx.doi.org/10.2139/ssrn.2933052

Jongsub Lee

University of Florida - Warrington College of Business Administration ( email )

Department of Finance Insurance & Real Estate
P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-273-4966 (Phone)
352-392-0301 (Fax)

Andy Naranjo

University of Florida - Warrington College of Business Administration ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3781 (Phone)

Guner Velioglu (Contact Author)

University of Florida - Warrington College of Business Administration ( email )

Gainesville, FL 32611
United States

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