Cost Rigidity and CDS Spreads
48 Pages Posted: 31 Aug 2018
Date Written: August 13, 2017
We provide evidence that credit investors do not fully impound the implications of firms’ cost structure when pricing credit default swaps. Information about firms’ cost structure is not disclosed and needs to be estimated. Furthermore, the performance implications of firms’ cost structure depend on the expected macroeconomic conditions. We focus on the debt market because of the strong emphasis of this market on downside risk. To measure expected aggregate macroeconomic conditions, we employ the expected change in the anxious index (hereinafter AI), the probability of a decline in real GDP, provided by the SPF — the survey of professional forecasters. We interact this index with the firm’s cost structure, and find that this interaction predicts future one-quarter-ahead CDS spreads. Portfolio-level analysis shows that a high-cost-rigidity portfolio is more sensitive to change in expected macroeconomic conditions and further confirms our predictability result.
Keywords: Cost Structure, Credit Spreads, Macroeconomic Forecast
JEL Classification: G12, G14, G32
Suggested Citation: Suggested Citation