Enhanced disclosure of credit derivatives, information asymmetry and credit risk

This study examines the extent to which enhanced disclosure of credit derivatives [Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) Financial Accounting Standards (FAS) No. 133‐1] reduces information asymmetry and credit derivative sellers who experience a decrease in information asymmetry. I find that bid‐ask spread for credit derivative sellers with positive net protection is reduced in the post‐period, whereas that of sellers with negative net protection and the control groups is not. These results are consistent with the conjecture that market participants use enhanced disclosure to confirm or correct previous expectations about sellers’ credit risk. In addition, results in high versus low institutional groups suggest that bid‐ask spreads reduce in both groups but reduce more in the high institutional group in the post‐period, possibly due to information environment differences. Finally, I investigate the information content of two credit derivative exposure measures: maximum payment amount and fair value. Consistent with McAnally (1996), I find that the maximum payment amount is credit risk‐relevant. Thus, enhanced disclosure facilitates monitoring risk concentration and evaluating credit risk, thereby contributing to the stabilization of capital markets prior to regulation of the credit default swap (CDS) market.