Credit Shock Propagation Along Supply Chains: Evidence from the CDS Market

Abstract

Using a panel of Credit Default Swap (CDS) spreads and supply chain links, we observe that both favorable and unfavorable credit shocks propagate through supply chains in the CDS market. Particularly, the three-day cumulative abnormal CDS spread change (CASC) is 63 basis points for firms whose customer experienced a CDS up-jump event (that is, an adverse credit shock). The value is 74 basis points if a supplier experienced a CDS up-jump event. The corresponding three-day CASC values are −36 and −38 basis points, respectively, for firms whose customer and supplier,respectively, experienced an extreme CDS down-jump event (that is, a favorable credit shock). Such effects do not exist in inactive supply chains. The credit shock propagation is substantially more pronounced if supply-chain partners are followed by the same analysts. Industry competition and financial linkages between supply chain partners, such as trade credit and large sales exposure, amplify the shock propagation along supply chains. Strong shock propagation persists through second and third supply-chain tiers for adverse shocks, but attenuates for favorable shocks.

Keywords: supply chains, credit risk, CDS, propagation, supply networks

JEL Classification: E43, E51, G12, G14, G23, G24, G32, L11, L22