The Impact of Earnings on the Pricing of Credit Default Swaps

37 Pages Posted: 7 Dec 2006

See all articles by Jeffrey L. Callen

Jeffrey L. Callen

University of Toronto - Rotman School of Management

Joshua Livnat

New York University; Prudential Financial - Quantitative Management Associates

Dan Segal

Interdisciplinary Center (IDC) Herzliyah

Multiple version iconThere are 2 versions of this paper

Date Written: February 15, 2007

Abstract

This study evaluates the impact of earnings on firm credit risk as captured by Credit Default Swaps (CDS). We find that earnings (changes) are negatively correlated with one-year swap premia (changes) after controlling for equity returns but not with longer term premia (changes). We also find that earnings surprises are significantly correlated with one-year CDS premia changes in the short window surrounding preliminary earnings dates and that absolute earnings surprises are significantly correlated with absolute one-year CDS premia changes in the short window surrounding SEC filing dates. These results suggest that high earnings convey favorable information about the short-term default risk of firms but not about the long term default risk. We further document that accruals/cash flow information conveyed by SEC filings provides information about long-term credit risk. Furthermore, the empirical results are consistent with structural and hybrid model-driven implications of CDS pricing.

Keywords: Credit Default Swaps, credit risk, earnings

JEL Classification: M41, M43, G12, G14, G38

Suggested Citation

Callen, Jeffrey L. and Livnat, Joshua and Segal, Dan, The Impact of Earnings on the Pricing of Credit Default Swaps (February 15, 2007). Available at SSRN: https://ssrn.com/abstract=949322 or http://dx.doi.org/10.2139/ssrn.949322

Jeffrey L. Callen (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
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416-946-5641 (Phone)
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Joshua Livnat

New York University ( email )

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Stern School of Business
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United States
212-998-0022 (Phone)
212-995-4004 (Fax)

Prudential Financial - Quantitative Management Associates ( email )

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Newark, NJ 07102
United States

Dan Segal

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

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