Level 3 Assets and Credit Risk

38 Pages Posted: 25 Mar 2017

See all articles by May Xiaoyan Bao

May Xiaoyan Bao

University of New Hampshire - Peter T. Paul College of Business and Economics

Yixin Liu

University of New Hampshire

Date Written: October 23, 2016

Abstract

We examine the impact of Level 3 assets held by non-financial companies on credit risk. Specifically, we investigate how the pricing uncertainty of Level 3 assets is reflected in credit ratings, corporate bond yield spreads, and incidences of bond covenants. We find that higher holdings of Level 3 assets are associated with lower credit ratings, higher yield spreads, especially for Level 3 assets sample, and incidences of bondholder-friendly covenants in the bond issues. Our findings are robust to the treatment of sample selection bias and the influence of macroeconomic factors. In addition, our direct test on the relation between the holdings of Level 3 assets and a firm’s distance-to-default shows that higher holdings of Level 3 assets reduce a firm’s distance-to-default. Overall, our findings support the view that Level 3 assets are perceived as increasing credit risk in the bond market.

Keywords: Level 3 Assets; Cost of Debt; Credit Rating, Covenants; Credit Risk

JEL Classification: M41, G30

Suggested Citation

Bao, May Xiaoyan and Liu, Yixin, Level 3 Assets and Credit Risk (October 23, 2016). Available at SSRN: https://ssrn.com/abstract=2940416 or http://dx.doi.org/10.2139/ssrn.2940416

May Xiaoyan Bao (Contact Author)

University of New Hampshire - Peter T. Paul College of Business and Economics ( email )

10 Garrison Avenue
Durham, NH 03824
United States

Yixin Liu

University of New Hampshire ( email )

Durham, NH 03824
United States
603-862-3357 (Phone)

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