رابطه بین گسترش اعتباری پیش فرض معاوضه، بازده اوراق قرضه و رتبه بندی اعتباری

A company’s credit default swap spread is the cost per annum for protection against a default by the company. In this paper we analyze data on credit default swap spreads collected by a credit derivatives broker. We first examine the relationship between credit default spreads and bond yields and reach conclusions on the benchmark risk-free rate used by participants in the credit derivatives market. We then carry out a series of tests to explore the extent to which credit rating announcements by Moody’s are anticipated by participants in the credit default swap market.

Credit derivatives are an exciting innovation in financial markets. They have the potential to allow companies to trade and manage credit risks in much the same way as market risks. The most popular credit derivative is a credit default swap (CDS). This contract provides insurance against a default by a particular company or sovereign entity. The company is known as the reference entity and a default by the company is known as a credit event. The buyer of the insurance makes periodic payments to the seller and in return obtains the right to sell a bond issued by the reference entity for its face value if a credit event occurs. The rate of payments made per year by the buyer is known as the CDS spread. Suppose that the CDS spread for a 5-year contract on Ford Motor Credit with a principal of $10 million is 300 basis points. This means that the buyer pays $300,000 per year and obtains the right to sell bonds with a face value of $10 million issued by Ford for the face value in the event of a default by Ford.1 The credit default swap market has grown rapidly since the International Swaps and Derivatives Association produced its first version of a standardized contract in 1998. Credit ratings for sovereign and corporate bond issues have been produced in the United States by rating agencies such as Moody’s and Standard and Poor’s (S&P) for many years. In the case of Moody’s the best rating is Aaa. Bonds with this rating are considered to have almost no chance of defaulting in the near future. The next best rating is Aa. After that come A, Baa, Ba, B and Caa. The S&P ratings corresponding to Moody’s Aaa, Aa, A, Baa, Ba, B, and Caa are AAA, AA, A, BBB, BB, B, and CCC, respectively. To create finer rating categories Moody’s divides its Aa category into Aa1, Aa2, and Aa3; it divides A into A1, A2, and A3; and so on. Similarly S&P divides its AA category into AA+, AA, and AA−; it divides its A category into A+, A, and A−; etc. Only the Moody’s Aaa and S&P AAA categories are not subdivided. Ratings below Baa3 (Moody’s) and BBB− (S&P) are referred to as “below investment grade”. Analysts and commentators often use ratings as descriptors of the creditworthiness of bond issuers rather than descriptors of the quality of the bonds themselves. This is reasonable because it is rare for two different bonds issued by the same company to have different ratings. Indeed, when rating agencies announce rating changes they often refer to companies, not individual bond issues. In this paper we will similarly assume that ratings are attributes of companies rather than bonds. The paper has two objectives. The first is to examine the relationship between credit default swap spreads and bond yields. The second is to examine the relationship between credit default swap spreads and announcements by rating agencies. The analyses are based on over 200,000 CDS spread bids and offers collected by a credit derivatives broker over a 5-year period. In the first part of the paper we point out that in theory the N-year CDS spread should be close to the excess of the yield on an N-year bond issued by the reference entity over the risk-free rate. This is because a portfolio consisting of a CDS and a par yield bond issued by the reference entity is very similar to a par yield risk-free bond. We examine how well the theoretical relationship between CDS spreads and bond yield spreads holds. A number of other researchers have independently carried out related research. Longstaff et al. (2003), using the Treasury rate as the benchmark risk-free rate, and find significant differences between credit default swap spreads and bond yield spreads. Blanco et al. (2003) use the swap rate as the risk-free rate and find credit default swap spreads to be quite close to bond yield spreads. They also find that the credit default swap market leads the bond market so that most price discovery occurs in the credit default swap market. Houweling and Vorst (2002) confirm that the credit default swap market appears to use the swap rate rather than the Treasury rate as the risk-free rate. Our research is consistent with these findings. We adjust CDS spreads to allow for the fact that the payoff does not reimburse the buyer of protection for accrued interest on bonds. We estimate that the market is using a risk-free rate about 10 basis points less than the swap rate. The second part of the paper looks at the relationship between credit default swap spreads and credit ratings. Some previous research has looked at the relationship between stock returns and credit ratings. Hand et al. (1992) find negative abnormal stock returns immediately after a review for downgrade or a downgrade announcement, but no effects for upgrades or positive reviews. Goh and Ederington (1993) find negative stock market reaction only to downgrades associated with a deterioration of firm’s financial prospects but not to those attributed to an increase in leverage or reorganization. Cross-sectional variation in stock market reaction is documented by Goh and Ederington (1999) who find a stronger negative reaction to downgrades to and within non-investment grade than to downgrades within the investment grade category. Cornell et al. (1989) relates the impact of rating announcements to the firm’s net intangible assets. Pinches and Singleton (1978) and Holthausen and Leftwich (1986) find that equity returns anticipate both upgrades and downgrades. Other previous research has considered bond price reactions to rating changes. Katz (1974) and Grier and Katz (1976) look at monthly changes in bond yields and bond prices, respectively. They conclude that in the industrial bond market there was some anticipation before decreases, but not increases. Using daily bond prices, Hand et al. (1992) find significant abnormal bond returns associated with reviews and rating changes.2Wansley et al. (1992) confirm the strong negative effect of downgrades (but not upgrades) on bond returns during the period just before and just after the announcement. Their study concludes that negative excess returns are positively correlated with the number of rating notches changed and with prior excess negative returns.3 This effect is not related to whether the rating change caused the firm to become non-investment grade. By contrast, Hite and Warga (1997) find that the strongest bond price reaction is associated with downgrades to and within the non-investment grade class. Their findings are confirmed by Dynkin et al. (2002) who report significant underperformance during the period leading up to downgrades with the largest underperformance being observed before downgrades to below investment grade. A recent study by Steiner and Heinke (2001) uses Eurobond data and detects that negative reviews and downgrades cause abnormal negative bond returns on the announcement day and the following trading days but no significant price changes are observed for upgrades and positive review announcements. This asymmetry in the bond market’s reaction to positive and negative announcements was also documented by Wansley et al. (1992) and Hite and Warga (1997). Credit default swap spreads are an interesting alternative to bond prices in empirical research on credit ratings for two reasons.4 The first is that the CDS spread data provided by a broker consists of firm bid and offer quotes from dealers. Once a quote has been made, the dealer is committed to trading a minimum principal (usually $10 million) at the quoted price. By contrast the bond yield data available to researchers usually consist of indications from dealers. There is no commitment from the dealer to trade at the specified price. The second attraction of CDS spreads is that no adjustment is required: they are already credit spreads. Bond yields require an assumption about the appropriate benchmark risk-free rate before they can be converted into credit spreads. As Section 3 will discuss, the usual practice of calculating the credit spread as the excess of the bond yield over a similar Treasury yield is questionable. As one would expect, the CDS spread for a company is negatively related to its credit rating: the worse the credit rating, the higher the CDS spread. However, there is quite a variation in the CDS spreads that are observed for companies with a given credit rating. In Section 4 of the paper we consider a number of questions such as: To what extent do CDS spreads increase (decrease) before and after downgrade (upgrade) announcements? Are companies with relatively high (low) CDS spreads more likely to be downgraded (upgraded)? Does the length of time that a company has been in a rating category before a rating announcement influence the extent to which the rating change is anticipated by CDS spreads? In addition to the credit rating change announcements, we consider other information produced by Moody’s that may influence, or be influenced by, credit default swap spreads. These are reviews (also called Watchlists), and outlook reports. A review is typically either a review for upgrade or a review for downgrade.5 It is a statement by the rating agency that it has concerns about the current rating of the entity and is carrying out an active analysis to determine whether or not the indicated change should be made. The third type of rating event is an outlook report from a rating agency analyst. These reports are similar to the types of reports that an equity analyst with an investment bank might provide. They are distributed via a press release (available on the Moody’s website) and indicate the analyst’s forecast of the future rating of the firm. Outlooks fall into three categories: rating predicted to improve, rating predicted to decline, and no change in rating expected.6 To the best of our knowledge, ours is the first research to consider Moody’s outlook reports.7 The rest of this paper is organized as follows. Section 2 describes our data. Section 3 examines the relationship between CDS spreads and bond yields and reaches conclusions on the benchmark risk-free rate used in the credit derivatives market. Section 4 presents our empirical tests on credit rating announcements. Conclusions are in Section 5.

Credit default swaps are a recent innovation in capital markets. There is a theoretical relationship between credit default swap spreads and bond yield spreads. We find that the theoretical relationship holds fairly well and that we are able to use it to estimate the benchmark 5-year risk-free rate used by participants in the credit default swap market. Our conclusion is that the risk-free rate used by market participants is about 10 basis points less than the 5-year swap rate on average. Alternatively it can be characterized as above the Treasury rate by about 83% of the spread between the 5-year swap rate and the 5-year Treasury rate. We have conducted two types of analyses exploring the relationship between the credit default swap market and ratings announcements. In the first type of analysis we examine credit default swap changes conditional on a ratings announcement. We find that reviews for downgrade contain significant information, but downgrades and negative outlooks do not. There is anticipation of all three types of ratings announcements by the credit default swap market. In the second type of analysis we examine ratings announcements conditional on credit spread levels and credit spread changes. Either credit spread changes or credit spread levels provide helpful information in estimating the probability of negative credit rating changes. We find that 42.6% of downgrades, 39.8% of all reviews for downgrade and 50.9% of negative outlooks come from the top quartile of credit default swap changes. Our results for positive rating events were much less significant than our results for negative rating events. This is consistent with the work of researchers who have looked at the relationship between rating events and bond yields, but may be influenced by the fact that there were far fewer positive rating events in our sample.