Withholding Bad News in the Face of Credit Default Swaps Trading: Evidence from Stock Price Crash Risk
56 Pages Posted: 15 Jul 2017 Last revised: 26 Jun 2020
Date Written: June 25, 2020
The credit default swaps (CDS) market provides a trading venue for downside price movement. We find that future stock price crashes are less frequent after the inception of CDS trading on the firm’s debt. The causal effect of CDS trading on stock crash risk is supported by multiple approaches, including propensity score matching and entropy balancing analysis. The crash-reduction effect is stronger when CDS trading is more active or when corporate managers are more likely to hide bad news. Our findings suggest that CDS trading facilitates the gradual incorporation of withheld bad news into stock prices. Overall, our paper provides a new insight that financial innovations in the debt market help price discovery in the equity market that curtails the negative equity market effects of firms withholding bad news.
Keywords: credit default swaps; stock price crash risk; price discovery; bad news hoarding
JEL Classification: G10; G14; G32; M41
Suggested Citation: Suggested Citation