CDS spreads as an independent measure of credit risk

Florian Kiesel (Department of Business Administration, Economics and Law, Technische Universität Darmstadt, Darmstadt, Germany)
Jonathan Spohnholtz (Department of Business Administration, Economics and Law, Technische Universität Darmstadt, Darmstadt, Germany)

Journal of Risk Finance

ISSN: 1526-5943

Publication date: 20 March 2017

Abstract

Purpose

The creditworthiness of corporates is most visible in credit ratings. This paper aims to present an alternative credit rating measure independently of credit rating agencies. The credit rating score (CRS) is based on the credit default swap (CDS) market trading.

Design/methodology/approach

A CRS is developed which is a linear function of logarithmized CDS spreads. This new CRS is the first one that is completely independent of the 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 CRS 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 CRS is able to anticipate agency ratings in advance. Moreover, the analysis shows that the trading volume has only a 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.

Keywords

Citation

Kiesel, F. and Spohnholtz, J. (2017), "CDS spreads as an independent measure of credit risk", Journal of Risk Finance, Vol. 18 No. 2, pp. 122-144. https://doi.org/10.1108/JRF-09-2016-0119

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Publisher

:

Emerald Publishing Limited

Copyright © 2017, Emerald Publishing Limited

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