Abstract - Credit Derivatives, Corporate News, and Credit Ratings

The market for credit default swaps (CDS) represents an interesting venue to study if and how public and private information is incorporated in market prices. This OTC market is neither regulated nor supervised and exclusively made up by institutional traders that buy and sell credit risk. Considering the key importance of rating announcements for market participants, this paper investigates announcement and anticipation effects, conditioning on public information and using proxies for private information about CDS underlyings. Analyzing an international sample of frequently traded firms during the period 2000-2005 on a daily basis yields the following results. First, CDS markets significantly react to rating downgrades and, even stronger, to reviews for downgrade, while the magnitude of anticipation effects is the other way round. Second, the CDS market response is stronger for firms with high general media coverage. Moreover, rating-related wire news prior to rating events significantly explain the anticipation of CDS markets when general media coverage is high. Third, the run up is more pronounced the higher a firm’s number of major bank lenders and there is a signifcantly higher number of days with large positive abnormal price changes and no news (or no negative news) before rating events than in the full sample. These findings are consistent with the view that private information of banks spills over to these markets through their CDS trading.

Lars Norden
Rotterdam School of Management, Erasmus University
19.Jan 2010

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