Credit Risk Signals in CDS Market vs. Agency Ratings

Journal of Risk Finance, Vol. 17 No. 2, pp. 194-217. 2016 DOI:10.1108/JRF-07-2015-0070

Posted: 9 Jul 2020

See all articles by Michael Jacobs

Michael Jacobs

Accenture Consulting

Ahmet K Karagozoglu

Hofstra University, Zarb School of Business; New York University (NYU) - Volatility and Risk Institute

Dina Naples Layish

Binghamton University - School of Management

Date Written: 2016

Abstract

This research aims to model the relationship between the credit risk signals in the credit default swap (CDS) market and agency credit ratings, and determines the factors that help explain the variation in such signals. A comprehensive analysis of the differences in the relative credit risk assessments of CDS-based risk signals and agency ratings is provided. It is shown that the divergence between credit risk signals in the CDS market and agency ratings is explained by factors which the rating agencies may consider differently than credit market participants. The results suggest that agency credit ratings of relative riskiness of a reference entity do not always correspond with assessments by CDS spreads, as the price of risk is a function of additional macro and micro factors that can be explained using statistical analysis. This research is unique in modeling the relationship between the credit risk assessments of the CDS market and the agency ratings, which to the best of the authors’ knowledge has not been analyzed before in terms of their agreement and the level of discrepancy between them. This model can be used by investors in debt instruments that are not explicitly CDSs or which have illiquid CDS contracts, to replicate market-based, point-in-time credit risk signals. Based on both market-based and firm-specific factors in this model, the results can be used to augment through-the-cycle credit risk assessments, analyze issues surrounding the pricing of CDSs and examine the policies of credit rating agencies.

Keywords: CDS, credit rating agencies, credit risk, credit default swap, credit ratings

JEL Classification: G10, G20, G24, G28, G32

Suggested Citation

Jacobs, Michael and Karagozoglu, Ahmet K and Layish, Dina Naples, Credit Risk Signals in CDS Market vs. Agency Ratings (2016). Journal of Risk Finance, Vol. 17 No. 2, pp. 194-217. 2016 DOI:10.1108/JRF-07-2015-0070, Available at SSRN: https://ssrn.com/abstract=3628744

Michael Jacobs

Accenture Consulting ( email )

1345 Avenue of the Americas
New York, NY 10105
United States
9173242098 (Phone)

Ahmet K Karagozoglu (Contact Author)

Hofstra University, Zarb School of Business ( email )

Department of Finance
148 Hofstra University
Hempstead, NY 11549-1480
United States
(516) 463-5701 (Phone)
(718) 701-8331 (Fax)

HOME PAGE: http://sites.hofstra.edu/ahmet-karagozoglu

New York University (NYU) - Volatility and Risk Institute ( email )

44 West 4th Street
New York, NY 10012
United States

Dina Naples Layish

Binghamton University - School of Management ( email )

P.O. Box 6015, Office: A-278
Binghamton, NY 13902-6015
United States
607-777-6854 (Phone)

Here is the Coronavirus
related research on SSRN

Paper statistics

Abstract Views
55
PlumX Metrics