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When do CDS spreads lead? Rating events, private entities, and firm-specific information flows

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  • Lee, Jongsub
  • Naranjo, Andy
  • Velioglu, Guner

Abstract

We find that credit default swap (CDS) spreads contribute significantly to price discovery in financial markets when firm-specific credit information is prominent. Using 3,470 S&P rating notch and watch changes for US public and private entities from 2001–2013, we show that CDS prices contain unique firm credit risk information that is not captured by the prices of other related securities such as stocks and bonds of the same firm. Credit information unidirectionally flows from CDS to bonds, particularly for private entities whose stocks are not concurrently trading in markets. We further find that CDS returns significantly predict stock returns, particularly their idiosyncratic components.

Suggested Citation

  • Lee, Jongsub & Naranjo, Andy & Velioglu, Guner, 2018. "When do CDS spreads lead? Rating events, private entities, and firm-specific information flows," Journal of Financial Economics, Elsevier, vol. 130(3), pages 556-578.
    • Handle: RePEc:eee:jfinec:v:130:y:2018:i:3:p:556-578
    DOI: 10.1016/j.jfineco.2018.07.011
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    More about this item

    Keywords

    CDS versus stocks and bonds; Credit ratings; Firm-specific credit information flow; Lead-lag relations; Private firms;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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