Hostname: page-component-78c5997874-dh8gc Total loading time: 0 Render date: 2024-11-13T23:00:30.888Z Has data issue: false hasContentIssue false
  • English
  • Français

Credit Default Swaps and Firm Value

Published online by Cambridge University Press:  02 April 2018

Rajesh Narayanan  and
Cihan Uzmanoglu
Get access Rights & Permissions [Opens in a new window]

Abstract

This article provides evidence that firm value declines when credit default swaps (CDSs) are initiated and that the effect is greater when CDS trading activity is higher. This decline, which arises from an increase in the cost of capital as opposed to a decrease in free cash flows, traces to a deterioration in the firm’s credit quality and stock liquidity. Firm value declines less when CDS trading is likely to produce incremental information, suggesting that CDS trading has informational benefits for firm value. However, the evidence does not indicate that firm value increases because CDS availability facilitates investments.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 3 , June 2018 , pp. 1227 - 1259
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank Murillo Campello, Jennifer Conrad (the editor), Emre Demirezen, Rory Eckardt, Oleg Gredil, Umit Gurun, Hyoseok Hwang, Murali Jagannathan, Chanatip Kitwiwattanachai, Tomislav Ladika, Andrew Lynch, Kristian Rydqvist, Sabatino Silveri, Musa Subasi, Dragon Tang (the referee), and participants at the 2015 Financial Management Association Meeting for helpful comments and Xiang Gao and Rong Guo for excellent research assistance.

References

Acharya, V. V., and Johnson, T. C.. “Insider Trading in Credit Derivatives.” Journal of Financial Economics, 84 (2007), 110–141.CrossRefGoogle Scholar
Almeida, H., and Philippon, T.. “Estimating Risk-Adjusted Costs of Financial Distress.” Journal of Applied Corporate Finance, 20 (2008), 105–109.CrossRefGoogle Scholar
Amihud, Y.“Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
Amihud, Y., and Mendelson, H.. “Asset Pricing and the Bid-Ask Spread.” Journal of Financial Economics, 17 (1986), 223–249.CrossRefGoogle Scholar
Amiram, D.; Beaver, W.; Landsman, W. R.; and Zhao, J.. “The Effects of CDS Trading on Information Asymmetry in Syndicated Loans.” Journal of Financial Economics, 126 (2017), 364–382.CrossRefGoogle Scholar
Ashcraft, A. B., and Santos, J. A. C.. “Has the CDS Market Lowered the Cost of Corporate Debt?” Journal of Monetary Economics, 56 (2009), 514–523.CrossRefGoogle Scholar
Augustin, P.; Subrahmanyam, M. G.; Tang, D. Y.; and Wang, S. Q.. “Credit Default Swaps: A Survey.” Foundations and Trends in Finance, 9 (2014), 1–196.CrossRefGoogle Scholar
Batta, G. E.; Qiu, J.; and Yu, F.. “Credit Derivatives and Analyst Behavior.” Accounting Review, 91 (2016), 1315–1343.CrossRefGoogle Scholar
Bedendo, M.; Cathcart, L.; and El-Jahel, L.. “Distressed Debt Restructuring in the Presence of Credit Default Swaps.” Journal of Money, Credit and Banking, 48 (2016), 165–201.CrossRefGoogle Scholar
Bharath, S. T., and Shumway, T.. “Forecasting Default with the Merton Distance to Default Model.” Review of Financial Studies, 21 (2008), 1339–1369.CrossRefGoogle Scholar
Boehmer, E.; Chava, S.; and Tookes, H. E.. “Related Securities and Equity Market Quality: The Case of CDS.” Journal of Financial and Quantitative Analysis, 50 (2015), 509–541.CrossRefGoogle Scholar
Bolton, P., and Oehmke, M.. “Credit Default Swaps and the Empty Creditor Problem.” Review of Financial Studies, 24 (2011), 2617–2655.CrossRefGoogle Scholar
Cai, J.; Saunders, A.; and Steffen, S.. “Syndication, Interconnectedness, and Systemic Risk.” Working Paper, New York University (2011).CrossRefGoogle Scholar
Cao, H. H.“The Effect of Derivative Assets on Information Acquisition and Price Behavior in a Rational Expectations Equilibrium.” Review of Financial Studies, 12 (1999), 131–163.CrossRefGoogle Scholar
Chava, S., and Roberts, M. R.. “How Does Financing Impact Investment? The Role of Debt Covenants.” Journal of Finance, 63 (2008), 2085–2121.CrossRefGoogle Scholar
Chung, K. H., and Pruitt, S. W.. “A Simple Approximation of Tobin’s q .” Financial Management, 23 (1994), 70–74.CrossRefGoogle Scholar
Conrad, J.“The Price Effect of Option Introduction.” Journal of Finance, 44 (1989), 487–498.CrossRefGoogle Scholar
Danis, A.“Do Empty Creditors Matter? Evidence from Distressed Exchange Offers.” Management Science, 63 (2017), 1285–1301.CrossRefGoogle Scholar
Danis, A., and Gamba, A.. “The Real Effects of Credit Default Swaps.” Journal of Financial Economics, 127 (2018), 51–76.CrossRefGoogle Scholar
Das, S.; Kalimipalli, M.; and Nayak, S.. “Did CDS Trading Improve the Market for Corporate Bonds?” Journal of Financial Economics, 111 (2014), 495–525.CrossRefGoogle Scholar
Davydenko, S. A., and Strebulaev, I. A.. “Strategic Actions and Credit Spreads: An Empirical Investigation.” Journal of Finance, 62 (2007), 2633–2671.CrossRefGoogle Scholar
Diamond, D. W., and Verrecchia, R. E.. “Disclosure, Liquidity, and the Cost of Capital.” Journal of Finance, 46 (1991), 1325–1359.CrossRefGoogle Scholar
Easley, D., and O’Hara, M.. “Information and the Cost of Capital.” Journal of Finance, 59 (2004), 1553–1583.CrossRefGoogle Scholar
Fama, E., and French, K.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E., and French, K.. “Industry Cost of Equity.” Journal of Financial Economics, 43 (1997), 153–193.CrossRefGoogle Scholar
Fang, V. W.; Noe, T. H.; and Tice, S.. “Stock Market Liquidity and Firm Value.” Journal of Financial Economics, 94 (2009), 150–169.CrossRefGoogle Scholar
Gompers, P. A.; Ishii, J.; and Metrick, A.. “Extreme Governance: An Analysis of Dual-Class Firms in the United States.” Review of Financial Studies, 23 (2010), 1051–1088.CrossRefGoogle Scholar
Heckman, J. J.“Sample Selection Bias as a Specification Error.” Econometrica, 47 (1979), 153–161.CrossRefGoogle Scholar
Hu, H. T. C., and Black, B. S.. “Debt, Equity and Hybrid Decoupling: Governance and Systemic Risk Implications.” European Financial Management, 14 (2008), 663–709.CrossRefGoogle Scholar
Maddala, G. S. Limited Dependent and Qualitative Variables in Econometrics. Cambridge, MA: Cambridge University Press (1983).CrossRefGoogle Scholar
Maddala, G. S.“A Perspective on the Use of Limited-Dependent and Qualitative Variables Models in Accounting Research.” Accounting Review, 66 (1991), 788–807.Google Scholar
Merton, R. C.“On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449–470.Google Scholar
Morrison, A. D.“Credit Derivatives, Disintermediation and Investment Decisions.” Journal of Business, 78 (2005), 621–648.CrossRefGoogle Scholar
Narayanan, R., and Uzmanoglu, C.. “Credit Insurance, Distress Resolution Costs, and Bond Spreads.” Financial Management, forthcoming (2018).CrossRefGoogle Scholar
Ni, S. X., and Pan, J.. “Trading Puts and CDS on Stocks with Short Sale Ban.” Working Paper, Hong Kong University of Science and Technology (2015).Google Scholar
Parlour, C. A., and Winton, A.. “Laying Off Credit Risk: Loan Sales versus Credit Default Swaps.” Journal of Financial Economics, 107 (2013), 25–45.CrossRefGoogle Scholar
Pastor, L., and Veronesi, P.. “Stock Valuation and Learning about Profitability.” Journal of Finance, 58 (2003), 1749–1789.CrossRefGoogle Scholar
Petersen, M. A.“Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches.” Review of Financial Studies, 22 (2009), 435–480.CrossRefGoogle Scholar
Roll, R.; Schwartz, E.; and Subrahmanyam, A.. “Options Trading Activity and Firm Valuation.” Journal of Financial Economics, 94 (2009), 345–360.CrossRefGoogle Scholar
Saretto, A., and Tookes, H. E.. “Corporate Leverage, Debt Maturity, and Credit Supply: The Role of Credit Default Swaps.” Review of Financial Studies, 26 (2013), 1190–1247.CrossRefGoogle Scholar
Schneider, P.; Sögner, L.; and Veža, T.. “The Economic Role of Jumps and Recovery Rates in the Market for Corporate Default Risk.” Journal of Financial and Quantitative Analysis, 45 (2010), 1517–1547.CrossRefGoogle Scholar
Sorescu, S. M.“The Effect of Options on Stock Prices: 1973 to 1995.” Journal of Finance, 55 (2000), 487–514.CrossRefGoogle Scholar
Subrahmanyam, M. G.; Tang, D. Y.; and Wang, S. Q.. “Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk.” Review of Financial Studies, 27 (2014), 2927–2960.CrossRefGoogle Scholar
Subrahmanyam, M. G.; Tang, D. Y.; and Wang, S. Q.. “Credit Default Swaps, Exacting Creditors and Corporate Liquidity Management.” Journal of Financial Economics, 124 (2017), 395–414.CrossRefGoogle Scholar
Vassalou, M., and Xing, Y.. “Default Risk in Equity Returns.” Journal of Finance, 59 (2004), 831–868.CrossRefGoogle Scholar
Wooldridge, J. Econometric Analysis of Cross Section and Panel Data. Cambridge, MA: MIT Press (2002).Google Scholar
Supplementary material: File

Narayanan and Uzmanoglu supplementary material 1

Appendix

Download Narayanan and Uzmanoglu supplementary material 1(File)
File 790.5 KB