Information Content of Credit Default Swaps: Price Discovery, Risk Transmission, and News Impact

Abstract

This thesis comprises three empirical studies regarding information content of credit default swap (CDS). The first study provides further evidence of credit risk discovery between CDS and stock of the U.S. non-financial firms. Stock generally leads CDS in discovering credit risk information, with the exception of the stressful financial crisis period of 2008–2010. The CDS of investment-grade firms generally possesses higher informational efficiency than that of speculative-grade firms. High funding cost and central clearing counterparty hinder CDS from rapidly incorporating credit risk news.

The second study investigates dynamics and determinates of credit risk transmission across the global systemically important financial institutions (G-SIFIs). The aggregate credit risk transmission across G-SIFIs dramatically increases from mid-2006 to mid-2008 and then fluctuates around 90% until 2014. Global systemically important banks (G-SIBs) and the U.S.–based G-SIFIs are major credit risk providers. More interbank loans, more non-banking income, higher extra loss absorbency requirement, and lower Tier 1 leverage ratio are positively related to a G-SIB’s role in credit risk transmission. Global systemically important insurers (G-SIIs) which have more non-traditional non-insurance activities, larger sizes, and more global sales tend to be credit risk senders.

The final study examines the impact of sovereign credit rating and bailout events on sovereign CDS and equity index, especially their contemporaneous correlation, in the U.S., the U.K., and the Eurozone countries. The two assets are less negatively correlated at the arrivals of domestic rating events or surprises. Good and bad rating events present asymmetric effects on the asset correlation in Portugal, Netherlands, Ireland, Finland, and the U.S., while their symmetric effects are found in Spain, Italy, and Cyprus. Two assets become more negatively correlated on the announcement days of major bailouts. Bailout events have a stronger impact than domestic rating events. Greek rating news exerts spillover effect and generally has positive impact on the asset correlation in other economies.