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CDS spreads as an independent measure of credit risk

Kiesel, F. and Spohnholtz, J. (2017):
CDS spreads as an independent measure of credit risk.
In: The Journal of Risk Finance, Emerald Group Publishing Limited, pp. 122-144, 18, (2), ISSN 1526-5943, [Online-Edition: http://dx.doi.org/10.1108/JRF-09-2016-0119],
[Article]

Abstract

Purpose The creditworthiness of corporates is most visible in credit ratings. This paper presents an alternative credit rating measure independently of credit rating agencies. The credit rating score is based on the CDS market trading.

Design/methodology/approach A credit rating score is developed which is a linear function of logarithmized credit default swap (CDS) spreads. This new credit rating score is the first one completely independent of rating agency. The estimated ratings are compared with ratings provided by Fitch Ratings for 310 European and US non-financial corporates.

Findings The empirical analysis shows that logarithmized CDS spreads and issuer credit ratings by agencies have a linear relationship. The new credit rating score provides market participants with an alternative risk assessment, which is solely based on market factors, and does not rely on credit rating analysts. The results indicate that our credit rating score is able to anticipate agency ratings in advance. Moreover, the analysis demonstrates that the trading volume has only limited influence in the anticipation of rating changes.

Originality/value This study shows a new approach to measure the creditworthiness of firms by analyzing CDS spreads. This is highly relevant for regulation, firm monitoring, and investors.

Item Type: Article
Erschienen: 2017
Creators: Kiesel, F. and Spohnholtz, J.
Title: CDS spreads as an independent measure of credit risk
Language: English
Abstract:

Purpose The creditworthiness of corporates is most visible in credit ratings. This paper presents an alternative credit rating measure independently of credit rating agencies. The credit rating score is based on the CDS market trading.

Design/methodology/approach A credit rating score is developed which is a linear function of logarithmized credit default swap (CDS) spreads. This new credit rating score is the first one completely independent of rating agency. The estimated ratings are compared with ratings provided by Fitch Ratings for 310 European and US non-financial corporates.

Findings The empirical analysis shows that logarithmized CDS spreads and issuer credit ratings by agencies have a linear relationship. The new credit rating score provides market participants with an alternative risk assessment, which is solely based on market factors, and does not rely on credit rating analysts. The results indicate that our credit rating score is able to anticipate agency ratings in advance. Moreover, the analysis demonstrates that the trading volume has only limited influence in the anticipation of rating changes.

Originality/value This study shows a new approach to measure the creditworthiness of firms by analyzing CDS spreads. This is highly relevant for regulation, firm monitoring, and investors.

Journal or Publication Title: The Journal of Risk Finance
Volume: 18
Number: 2
Publisher: Emerald Group Publishing Limited
Divisions: 01 Department of Law and Economics > Betriebswirtschaftliche Fachgebiete
01 Department of Law and Economics > Betriebswirtschaftliche Fachgebiete > Corporate finance
01 Department of Law and Economics
Date Deposited: 15 Feb 2017 18:33
Official URL: http://dx.doi.org/10.1108/JRF-09-2016-0119
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