Accounting-based versus market-based cross-sectional models of CDS spreads

Das, Sanjiv Ranjan; Hanouna, Paul; Sarin, Atulya

doi:10.1016/j.jbankfin.2008.11.003

Cited by 206 publications

(72 citation statements)

References 53 publications

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“…Ericsson et al (2009) show that much of the variation in CDS spreads can be explained by structural model factors linked to firm fundamentals. Callen et al (2009) and Das et al (2009) find that accounting earnings are priced into the levels of and changes in CDS spreads, whereas De Franco et al (2009) show that CDS prices are responsive to debt analysts' reports. Shivakumar et al (2011) demonstrate that CDS pricing reacts significantly to management forecast news and that the reaction to forecast news is stronger than to actual earnings news.…”

Section: The Cds Market and Related Studiesmentioning

confidence: 99%

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Internal Control Quality and Credit Default Swap Spreads

Tang

Tian

Yan

2015

Accounting Horizons

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i Internal Control Quality and Credit Default Swap SpreadsSYNOPSIS: This paper presents the first study on the effects of internal control quality on derivatives pricing. Specifically, we utilize data from the credit default swap (CDS) transactions of well-monitored companies to examine the relationship between the quality of internal control and the cost of debt. The CDS data we employ are advantageous for our analysis because CDS contracts are comparatively more homogeneous, standardized, and liquid than bank loans and public bonds. We find that CDS spreads increase around the disclosure of internal control material weaknesses (MWs) and that, all else equal, companies experiencing MWs with respect to internal control have higher CDS spreads than companies with effective internal control.Moreover, companies with company-level MWs have higher CDS spreads than those with less severe, account-specific MWs. In addition, remediating internal control MWs is associated with a decrease in CDS spreads. Our study offers a new perspective on the relationship between the quality of internal control and the cost of debt. These conflicting results may be due to heterogeneous characteristics and measurement issues in using bank loans and public bonds to measure credit spreads. Covenants, embedded optionalities (such as callability and convertibility), and other complicating factors associated with bank loans and public bonds may distort the relationship between credit risk and internal control quality. Furthermore, because information on bank loans is only available when companies receive new loans, researchers are relegated to three-or four-year windows in their observations of changes in loan spreads (Dahilwal et al. 2011). By contrast, CDS contracts are relatively homogeneous and standardized, and CDS spreads reflect credit risk better than loan or 3 bond spreads (Shivakumar et al. 2011;Callen et al. 2009) because the CDS market is not as plagued with the liquidity issues that affect the public bond and bank loan markets. Therefore, CDS spreads are a superior means of examining the impact of internal control quality on credit pricing.We expect CDS spreads to be positively related to internal control MWs for two reasons.First, a firm that is experiencing MWs in internal control suggests that its financial reporting may be unreliable, which thereby increases the perceived information risk from the perspective of a credit investor. Such information risk related to unreliable information sources leads an investor to charge a higher credit risk premium (e.g., Duffie and Lando 2001;Lambert et al. 2007).Second, internal control MWs make it easier for managers to misappropriate a company's assets, which increases the default risk. For example, Skaife et al. (2013) report that the profitability of insider trading is significantly greater in firms with internal control MWs, which suggests the risk of expropriation of outside shareholders when there are weak internal controls.In an examination of the period from November 15, 2004, ...

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Section: The Cds Market and Related Studiesmentioning

confidence: 99%

“…Previous studies demonstrate that financial information (such as earnings) significantly affects CDS pricing (Das et al 2009;Callen et al 2009). We extend this line of research by providing evidence that CDS pricing is influenced by financial information risk proxied by the quality of internal control.…”

Section: Introductionmentioning

confidence: 99%

Internal Control Quality and Credit Default Swap Spreads

Tang

Tian

Yan

2015

Accounting Horizons

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“…For each firm-quarter observation, we collect different issuer-specific variables from CRSP and COMPUSTAT (chosen variables are along the lines of Das, Hanouna and Sarin (2009)). We drop all firm-quarter observations post CDS-introduction; that is, if CDS has been introduced for a firm prior to a given quarter, we drop that firm-quarter from the analysis (since CDS introduction is no longer a choice decision for these firms).…”

Section: Controlling For Endogeneitymentioning

confidence: 99%

Did CDS trading improve the market for corporate bonds?

Das

Kalimipalli

Nayak

2014

Journal of Financial Economics

121

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Did CDS Trading Improve the Market for Corporate Bonds?Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error) and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002-2008, we find that the advent of CDS was largely detrimental -bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specification of our tests.

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“…To the best of our knowledge, no study in the related literature has used specifically balance sheet variables to explain variation in CDS spreads. Most empirical papers (see for example Collin-Dufresne et al, 2001;Bystrom, 2005;Zhang et al, 2005;Duffie et al, 2007;Das et al, 2008) investigating the explanatory power of credit risk variables for bond and CDS include in the model several variables to proxy for business conditions, market conditions and/or uncertainty (term structure of interest rates, market return, market volatility, etc.). We are conscious of the influence market variables have on CDS spreads, however in this paper, because of the time period considered, we decided to focus only on the correlation between balance sheet ratios and CDS spreads.…”

Section: Introductionmentioning

confidence: 99%