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To change or not to change? The CDS market response of firms on credit watch

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  • Kiesel, Florian
  • Kolaric, Sascha
  • Norden, Lars
  • Schiereck, Dirk

Abstract

CDS spreads contain information about expected credit risk, but how accurate is this information when uncertainty about credit risk arises? We document that CDS spreads of firms on negative credit watch (review for downgrade) change systematically into the direction implied by the ex-ante uncertain review outcomes: they widen before reviews concluded with downgrades and tighten before reviews concluded with confirmations. Moreover, CDS spreads widen before deteriorations of corporate credit risk such as leverage, interest rate coverage and Altman Z-score that occur over the review period. Importantly, we do not find similar patterns for firms’ stock returns during the review period. The evidence is novel and suggests that the CDS market not only reflects the increase in uncertainty but also accurate forward-looking information about the outcomes of the uncertainty-inducing events.

Suggested Citation

  • Kiesel, Florian & Kolaric, Sascha & Norden, Lars & Schiereck, Dirk, 2021. "To change or not to change? The CDS market response of firms on credit watch," Journal of Banking & Finance, Elsevier, vol. 125(C).
    • Handle: RePEc:eee:jbfina:v:125:y:2021:i:c:s037842662100025x
    DOI: 10.1016/j.jbankfin.2021.106067
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    Cited by:

    1. Singh, Amanjot & Singh, Harminder, 2022. "Insiders' stock pledging disclosures and credit ratings: Evidence from India," Pacific-Basin Finance Journal, Elsevier, vol. 75(C).
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    3. Florian Kiesel, 2021. "It's the tone, stupid! Soft information in credit rating reports and financial markets," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 44(3), pages 553-585, September.

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    More about this item

    Keywords

    Credit default swaps; Uncertainty; Informational efficiency; Credit ratings; Rating reviews;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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