This study analyzes the motivations for and consequences of funds' credit default swap (CDS) investments using mutual funds' quarterly holdings from pre‐ to postfinancial crisis. Funds invest in CDS when facing unpredictable liquidity needs. Funds sell more in reference entities when the CDS is liquid relative to the underlying bonds and buy more when the CDS‐bond basis is more negative. To enhance yield, funds engage in negative basis trading and sell CDS with the highest spreads within rating categories, and with spreads higher than those of their bond portfolios. Funds with superior portfolio returns also demonstrate more skill in CDS trading

This paper examines whether the tone of corporate textual disclosures related to risk and uncertainty conveys relevant information to the credit default swap (CDS) market. Prior studies largely focus on the amount of risk disclosures and provide inconclusive evidence on the usefulness of risk disclosures for investors in assessing firm risk. Using a large sample of textual risk disclosures in the Management's Discussion and Analysis (MD&A) section of 10‐K and 10‐Q filings, I predict and find that the change in CDS spreads over the three‐day window surrounding the 10‐K/Q filing date is positively associated with the pessimism of the language used in the risk disclosures. I conduct several analyses to show that the effect of the tone of risk disclosures is distinguishable from that of the amount of such disclosures. Cross‐sectional analyses reveal that the CDS market reaction to the tone of MD&A risk disclosures is more pronounced for reference entities closer to default, consistent with creditors' particular concern about downside risk. Further, the CDS market reacts more significantly to the tone of MD&A risk disclosures for reference entities with a weaker information environment. Overall, these results support the view that the tone of textual risk disclosures in MD&As has information content for investors in the CDS market in particular and debt markets in general. My findings improve the understanding of textual risk disclosures by showing that the tone and the amount of such disclosures have different implications for debt market investors' risk perceptions

Since the global financial crisis, interest rate swap rates, which represent future uncollateralized interbank borrowing, have fallen below maturity-matched Treasury rates. This is surprising, because US Treasuries, which are deemed expensive because of superior liquidity and safety, should produce yields that are lower than those of swap rates. We show, by no-arbitrage, that sovereign default risk explains negative swap spreads even without frictions such as balance sheet constraints, convenience yield, and hedging demand. We support this explanation with an equilibrium model that jointly accounts for macroeconomic fundamentals and the term structures of interest and US credit default swap rates

We study the impact of stronger shareholder control on bondholders. We find that the passage of shareholder-sponsored governance proposals causes a decline in credit default swap spreads, indicating a net positive effect on bondholders. Evidence suggests that the direct benefit of stronger shareholder control, through the “management disciplining” channel, is larger than the combined adverse effects of directly escalating shareholder-bondholder conflict and indirectly exacerbating exposure to shareholder opportunism. Results are stronger for firms with existing high levels of shareholder-bondholder conflict and for proposals that mitigate managerial entrenchment without exacerbating risk-shifting. Finally, stronger shareholder control improves credit ratings and operating performance in the long-term

We use the advent of new credit default swap (CDS) trading conventions in April 2009—the CDS Big Bang—to study how a shock to funding liquidity impacts market liquidity. After the Big Bang, traders are required to pay upfront fees to execute CDS transactions, with the size of the fees depending on the level of CDS spreads. While CDS bid-ask spreads decline in aggregate after the Big Bang, they do so less for contracts that require larger fees. Furthermore, the funding effect is stronger for smaller and riskier firms and for noncentrally cleared contracts. The effect also becomes stronger after Deutsche Bank's exit

This paper provides early evidence on the effect of global regulation mandating a switch from loan loss provisioning (LLP) based on incurred credit losses (ICLs) to LLP based on expected credit losses (ECLs). Using a sample of systemically important banks from 74 countries, we find that ECL provisions are more predictive of future bank risk than ICL provisions. Corroborating that the switch to ECL provisioning results in more information to assess bank risk, we also observe that the announcement of a larger first‐time impact of the accounting change elicits lower stock returns and higher changes in credit default swap spreads. Critically, these patterns are most pronounced when credit conditions deteriorate. Additional analyses show that the higher information content of the ECL model stems from the provisions for nondefaulted loans, which did not exist under ICL. Our study contributes to the debate on the effect of the ECL model on procyclicality, an especially pressing issue in the context of the current pandemic

We provide evidence that credit investors do not fully impound the implications of firms' cost structure (or operating leverage) when pricing credit default swaps. Information about firms' cost structure is not disclosed and needs to be estimated. Furthermore, the performance implications of firms' cost structure depend on the expected macroeconomic conditions. We focus on the debt market because of the strong emphasis of this market on downside risk. To measure expected aggregate macroeconomic conditions, we employ the change in the anxious index (AI), which is the probability of a decline in real GDP provided by the SPF—the survey of professional forecasters. We find that the interaction between the firm's cost structure and change in AI predicts one-quarter-ahead CDS spreads. Portfolio-level analysis confirms this result

Raising capital on wholesale debt markets is an important source of funding for banks and non-banking institutions throughout the world. We investigate the determinants of wholesale funding costs for the Global Systematically Important Banks (G-SIBs) using credit default swaps, the proxy for the cost of wholesale debt funding. Using 25 G-SIBs which are heavily reliant on debt capital markets across multiple currencies, this paper investigates whether the default risk of the interbank lending system, i.e., LIBOR-OIS spread is a new global macroeconomic factor in determining G-SIBs’ CDS spreads. Based on time-fixed effects and bank-fixed effects, we find default risk from the US banking system seems to play a greater role in explaining the wholesale funding costs of the G-SIBs than that of their home-country equivalent default risk. Overall, the findings make an important contribution to domestic and international debt funding markets and provide an insight for financial intermediaries, regulators, and monetary-policy makers

This study develops and applies a model-implied measure of information imprecision. We define information imprecision as the degree of noise in investors' prior beliefs about the firm's asset value based on the information set that is currently available. We present a model of credit default swap (CDS) spreads in which the term structure is a function of information imprecision. We exploit observable CDS spreads with short and long maturities to extract an empirical measure of information imprecision. We then examine the moderating role of our measure in two settings. First, we show that the equity market response to credit rating changes increases in the level of information imprecision before the announcement. Second, we show that bond-market professionals' ability to charge a premium to smaller investors, relative to larger investors, increases in the issuing firm's information imprecision. This evidence illustrates the broad applicability of our model-implied measure of information imprecision