Ebook Accounting Transparency and the Term Structure of Credit Default Swap Spreads
Traditional structural credit risk models originating with Black & Scholes (1973) and Merton (1974) define default as the first passage of a perfectly measured asset value to a default barrier. While later extensions that allow for endogenous default and debt renegotiations have increased predicted spread levels, it is well(known in the empirical literature that structural models underpredict corporate bond credit spreads, particularly in the short end. Reasons for the poor performance may lie in shortcomings in the models as well as factors other than default risk in the corporate bond credit spread.
As noted in Duq e & Lando (2001), it is typically diq cult for investors in the secondary credit markets to observe a firmos assets directly, either because of noisy or delayed accounting reports or other barriers to monitoring. Instead, investors must draw inference from the available accounting data and other publicly available information. As a consequence they build a model where credit investors are not kept fully informed on the status of the firm, but receive noisy unbiased estimates of the asset value at selected times. This intuitively simple framework has a significant implication for the term structure of credit spreads.
In particular, for firms with perfectly measured assets credit spreads are relatively small at short maturities and zero at zero maturity, regardless of the riskiness of the firm. However, if firm assets periodically are observed with noise, credit spreads are strictly positive under the same limit because investors are uncertain about the distance of current assets to the default barrier.
This paper contributes to the existing literature by estimating the component of the term structure of credit spreads associated with a lack of accounting transparency. To this end, credit default swap (CDS) spreads at the 1, 3, 5, 7 and 10 year maturity for a large cross section of firms are used together with a newly developed measure of accounting transparency by Berger et al. (2006). This transparency measure is related to CDS spreads in two main ways.
First, it is used to estimate a gap between the high and low transparency credit curves. This gap interpreted as a transparency spread is estimated at 20 bps at the 1 year maturity and narrows to 14, 8, 7 and 5 bps at the 3, 5, 7 and 10 year maturity, respectively. The downward(sloping term structure of transparency spreads is highly significant in the short end but most often insignificantly estimated above the 5 year maturity. Furthermore, the effect of accounting transparency is largest for the most risky firms. These results are robust across alternative econometric specifications controlling for within cluster correlations and a large set of control variables.
Download
PDF Ebook Accounting Transparency and the Term Structure of Credit Default Swap Spreads
Posted in :
