Credit Derivatives and Corporate Default Prediction
41 Pages Posted: 12 May 2020
Date Written: April 16, 2020
There have been 91 defaults among U.S. CDS reference entities between 2002 and 2018. Within this sample, the five-year CDS spread significantly enhances the explanatory power of benchmark corporate default prediction models with equity market covariates and firm attributes, both in- and out-of-sample. This finding holds among financial and non-financial firms, and both within and without the great financial crisis. Moreover, the predictive power of the CDS spread is concentrated among entities with higher CDS market liquidity, while the illiquidity component of the CDS spread itself does not explain default. Lastly, neither the corporate bond yield spread nor CDS market indices explain default in the presence of firm-level CDS spreads. These results confirm the relevance of information contained in credit risk pricing to default prediction.
Keywords: Credit default swap, corporate default prediction, default risk, CDS liquidity
JEL Classification: G12, G13, G17, G23, G33
Suggested Citation: Suggested Citation