Corporate bond default risk: A 150-year perspective

We study corporate bond default rates using an extensive new data set spanning the 1866-2008 period. We find that the corporate bond market has repeatedly suffered clustered default events much worse than those experienced during the Great Depression. For example, during the railroad crisis of 1873-1875, total defaults amounted to 36% of the par value of the entire corporate bond market. Using a regime-switching model, we examine the extent to which default rates can be forecast by financial and macroeconomic variables. We find that stock returns, stock return volatility, and changes in GDP are strong predictors of default rates. Surprisingly, however, credit spreads are not. Over the long term, credit spreads are roughly twice as large as default losses, resulting in an average credit risk premium of about 80 basis points. We also find that credit spreads do not adjust in response to realized default rates.     

失信风险传染会影响债券定价吗？——基于担保网络大数据的实证研究

在债券定价研究中不仅应该考虑企业自身的信用风险,还应该考虑相关网络组织的传染风险。本文基于43万笔非金融企业间的担保数据,构建了企业信用担保网络,发现失信风险作为一种广义的信用风险,在担保网络中具有传染效应,该传染效应能够影响债券的信用利差。企业的失信行为产生了三类传染效应,一是直接传染效应,无论是发债主体的担保人出现失信行为,还是被担保人出现失信行为,都会引起发债主体的信用利差上升;二是局部感染效应,如果局部担保网络中失信主体的占比提升,可能引起投资者对发债主体的“团体处罚”,导致信用利差上升;三是全局扩散效应,失信信息沿担保网络向整个市场扩散,导致债券信用利差上升。从企业所有制来看,民营企业主要受微观的直接传染效应和中观的局部感染效应影响;而国有企业主要受全局扩散效应影响;被担保人的失信风险对两类企业都有显著影响。失信风险传染效应会降低企业的再融资能力,其中局部感染效应导致企业次年的借款融资额下降,全局扩散效应导致企业次年的债券融资额下降。     

Information risk and credit contagion

This paper demonstrates a positive relationship between information risk and the credit contagion effect. We use abnormal changes in the Credit Default Swaps (CDS) spreads to measure the contagion effect, and the dispersion of analyst forecasts as a proxy for information risk. We find that firms with higher information risk suffer a greater contagion effect that occurs in advance to the credit default events. This finding is robust under controls of key firm-specific characteristics and general condition of stock and credit markets.     

Determinants of yield spread dynamics: Euro versus US dollar corporate bonds

This paper presents a systematic comparison between the determinants of euro and US dollar yield spread dynamics. The results show that US dollar yield spreads are significantly more affected by changes in the level and the slope of the default-free term structure and the stock market return and volatility. Surprisingly, euro yield spreads are strongly affected by the US (and not the euro) level and slope. This confirms the dominance of US interest rates in the corporate bond markets. Interestingly, I find that liquidity risk is higher for US dollar corporate bonds than euro corporate bonds. For both regions, the effect of changes in the bid-ask spread is mainly significant during periods of high liquidity risk. Finally, the results indicate that the credit cycle as measured by the region-specific default probability significantly increases US yield spreads. This is not the case for euro yield spreads.     

A set-valued Markov chain approach to credit default

We propose a novel credit default model that takes into account the impact of macroeconomic factors and intergroup contagion on the defaults of obligors. We use a set-valued Markov chain to model the default process, which includes all defaulted obligors in the group. We obtain analytic characterizations for the default process and derive pricing formulas in explicit forms for synthetic collateralized debt obligations (CDOs). Furthermore, we use market data to calibrate the model and conduct numerical studies on the tranche spreads of CDOs. We find evidence to support that systematic default risk coupled with default contagion could have the leading component of the total default risk.     

CDOs and the financial crisis: Credit ratings and fair premia

We study risk and return characteristics of CDOs using the market standard models. We find that fair spreads on CDO tranches are much higher than fair spreads on similarly-rated corporate bonds. Our results imply that credit ratings are not sufficient for pricing, which is surprising given their central role in structured finance markets. This illustrates limitations of the rating methodologies that are solely based on real-world default probabilities or expected losses and do not capture risk premia. We also demonstrate that CDO tranches have large exposure to systematic risk and thus their ratings and prices are likely to decline substantially when credit conditions deteriorate.     

Modeling CDS spreads: A comparison of some hybrid approaches

According to the credit risk model proposed by Cathcart and El-Jahel (2006), default can occur either expectedly, when a certain signaling variable breaches a lower barrier, or unexpectedly, as the first jump of a Poisson process, whose intensity depends on the signaling variable itself and on the interest rate. In the present paper we test the performances of such a model and of other three models generalized by it in fitting the term structure of credit default swap (CDS) spreads. In order to do so, we derive a semi-analytical formula for pricing CDSs and we use it to fit the observed term structures of 65 different CDSs. The analysis reveals that all the model parameters yield a relevant contribution to credit spreads. Moreover, if the dependence of the default intensity on both the signaling variable and the interest rate is removed, the pricing of CDSs becomes very simple, from both the analytical and the computational standpoint, while the goodness-of-fit is reduced by only a few percentage points. Therefore, when using the credit risk model proposed by Cathcart and El-Jahel (2006), assuming a constant default intensity provides an interesting and efficient compromise between parsimony and goodness-of-fit. Furthermore, by fitting the term structure of CDS spreads on a period of about twelve years, we find that the parameters of the model with constant default are rather stable over time, and the goodness-of-fit is maintained high.     

A jump to default extended CEV model: an application of Bessel processes

We develop a flexible and analytically tractable framework which unifies the valuation of corporate liabilities, credit derivatives, and equity derivatives. We assume that the stock price follows a diffusion, punctuated by a possible jump to zero (default). To capture the positive link between default and equity volatility, we assume that the hazard rate of default is an increasing affine function of the instantaneous variance of returns on the underlying stock. To capture the negative link between volatility and stock price, we assume a constant elasticity of variance (CEV) specification for the instantaneous stock volatility prior to default. We show that deterministic changes of time and scale reduce our stock price process to a standard Bessel process with killing. This reduction permits the development of completely explicit closed form solutions for risk-neutral survival probabilities, CDS spreads, corporate bond values, and European-style equity options. Furthermore, our valuation model is sufficiently flexible so that it can be calibrated to exactly match arbitrarily given term structures of CDS spreads, interest rates, dividend yields, and at-the-money implied volatilities.     

Value investing in credit markets

We outline a parsimonious empirical model to assess the relative usefulness of accounting- and equity market-based information to explain corporate credit spreads. The primary determinant of corporate credit spreads is the physical default probability. We compare existing accounting-based and market-based models to forecast default. We then assess whether the credit market completely incorporates this default information into credit spreads. We find that credit spreads reflect information about forecasted default rates with a significant lag. This unique evidence suggests a role for value investing in credit markets.     

Directors’ and Officers’ liability insurance and bond credit spreads: Evidence from China

Using hand-collected data on purchases of D&O insurance by Chinese listed firms for the period from 2008 to 2019, we empirically find that D&O insurance negatively associates with credit spreads. The negative relationship still holds after conducting a series of robustness tests and is not driven by the eyeball effect. We also show that D&O insurance can reduce credit spreads via the channels of internal controls, external monitoring, information asymmetry and default risk. Moreover, the negative effect of D&O insurance on credit spreads is more pronounced for non-state-owned firms, those located in regions with a low level of marketization or that employ rating agencies with a bad reputation. Our study complements the literature on the credit spreads and corporate governance.     

Market conditions,default risk and credit spreads

This study empirically examines the impact of the interaction between market and default risk on corporate credit spreads. Using credit default swap (CDS) spreads, we find that average credit spreads decrease in GDP growth rate, but increase in GDP growth volatility and jump risk in the equity market. At the market level, investor sentiment is the most important determinant of credit spreads. At the firm level, credit spreads generally rise with cash flow volatility and beta, with the effect of cash flow beta varying with market conditions. We identify implied volatility as the most significant determinant of default risk among firm-level characteristics. Overall, a major portion of individual credit spreads is accounted for by firm-level determinants of default risk, while macroeconomic variables are directly responsible for a lesser portion.     

Cross country linkages and transmission of sovereign risk: Evidence from China’s credit default swaps

China’s climb to a trading powerhouse has changed its position in the world and therefore its relationships with other economies. As a result, its sovereign credit risk, which we measure by the pricing of its credit default swaps (CDS), now has the potential to greatly impact other sovereign CDS spreads. Employing a dynamic approach, we find that changes in China’s sovereign risk has strong contagion effects on its goods and service providers, while China is vulnerable to contagion effects from its major importers, suggesting sovereign risk spills over to other regions via the global supply chain. China’s success hurts some of the weaker countries in Europe by competing for their customers, while China faces strong competition itself from its export-focused neighbors. FDI and portfolio investment also affect the CDS relationships between China and other economies.     

Exploring the components of credit risk in credit default swaps

In this paper, we test the influence of various fundamental variables on the pricing of credit default swaps. The theoretical determinants that are important for pricing credit default swaps include the risk-free rate, industry sector, credit rating, and liquidity factors. We suggest a linear regression model containing these different variables, especially focusing on liquidity factors. Unlike bond spreads which have been shown to be inversely related to liquidity (i.e., the greater the liquidity, the lower the spread), there is no a priori reason that the credit default swap spread should exhibit the same relationship. This is due to the economic characteristics of a credit default swap compared to a bond. Our empirical result shows that all the fundamental variables investigated have a significant effect on the credit default swap spread. Moreover, our findings suggest that credit default swaps that trade with greater liquidity have a wider credit default swap spread.     

The effect of corporate diversification on credit risk: new evidence from European credit default swap spreads

This article investigates the impact of corporate diversification on credit risk. To our best knowledge, this is the first paper to use credit default swap (CDS) spreads instead of bond yield or revalued book values to test the risk‐reduction hypothesis. The analysis relies upon a sample of STOXX^® EUROPE 600 index members and covers the years 2010–2014. After controlling for various CDS‐ and firm‐specific variables, we find that diversification strategies do not significantly lower CDS premiums. Multilevel mediation analysis further shows that information asymmetries overcompensate the risk‐reducing effects resulting from corporate diversification.     

Credit Contagion from Counterparty Risk

Standard credit risk models cannot explain the observed clustering of default, sometimes described as "credit contagion." This paper provides the first empirical analysis of credit contagion via direct counterparty effects. We find that bankruptcy announcements cause negative abnormal equity returns and increases in CDS spreads for creditors. In addition, creditors with large exposures are more likely to suffer from financial distress later. This suggests that counterparty risk is a potential additional channel of credit contagion. Indeed, the fear of counterparty defaults among financial institutions explains the sudden worsening of the credit crisis after the Lehman bankruptcy in September 2008.     

Default Risk in Corporate Yield Spreads

An important research question examined in the credit risk literature focuses on the proportion of corporate yield spreads attributed to default risk. This topic is reexamined in light of the different issues associated with the computation of default probabilities obtained from historical default data. We find that the estimated default risk proportion in corporate yield spreads is sensitive to the ex ante estimated term structure of default probabilities used as inputs. This proportion can become a large fraction of the spread when sensitivity analyses are made with respect to the period over which the probabilities are estimated and the recovery rates.     

Modelling default contagion using multivariate phase-type distributions

We model dynamic credit portfolio dependence by using default contagion in an intensity-based framework. Two different portfolios (with ten obligors), one in the European auto sector, the other in the European financial sector, are calibrated against their market CDS spreads and the corresponding CDS-correlations. After the calibration, which are perfect for the banking portfolio, and good for the auto case, we study several quantities of importance in active credit portfolio management. For example, implied multivariate default and survival distributions, multivariate conditional survival distributions, implied default correlations, expected default times and expected ordered default times. The default contagion is modelled by letting individual intensities jump when other defaults occur, but be constant between defaults. This model is translated into a Markov jump process, a so called multivariate phase-type distribution, which represents the default status in the credit portfolio. Matrix-analytic methods are then used to derive expressions for the quantities studied in the calibrated portfolios.     

基于信用利差的中国城投债券信用风险分析

在"四万亿"投资的推动下,中国城投债券的发行规模大幅增加。与此同时,城投公司的整体债务规模也急剧攀升,其债务总量超过了地方政府的财政收入水平,城投公司的整体信用水平不容乐观。因此,城投债券的信用风险需引起足够重视。本文从量化角度研究了影响中国城投债券信用风险的四个因素,结果显示,中国城投债券的信用利差与发债企业的资产规模以及发债企业所在地区的人均GDP水平负相关,与企业债券收益率以及担保正相关。     

Do significant risk warnings in annual reports increase corporate bond credit spreads? Evidence from China

Based on listed companies issuing bonds on the Shanghai and Shenzhen Stock Exchanges from 2007 to 2017, this study analyzes the relationship between significant risk warnings in Chinese companies’ annual reports and corporate bond credit spreads. The main findings are as follows. First, in the Chinese market, “substantial warnings of significant risks” can significantly improve corporate bond credit spreads, reflecting the risk-warning effect; second, state-owned property rights weaken this effect, which only pertains to listed companies with poor risk management and low information quality; third, significant risk warnings increase investors’ heterogeneous beliefs, also affecting credit spreads; and fourth, through textual analysis, it is found that the corporate bond credit spread is greater when the disclosed risk factors are more pessimistic and less similar to those of the previous year. The findings of this paper help to enrich the literature on credit spreads and risk disclosure.     

Pricing default swaps: Empirical evidence

In this paper we compare market prices of credit default swaps with model prices. We show that a simple reduced form model outperforms directly comparing bonds' credit spreads to default swap premiums. We find that the model yields unbiased premium estimates for default swaps on investment grade issuers, but only if we use swap or repo rates as proxy for default-free interest rates. This indicates that the government curve is no longer seen as the reference default-free curve. We also show that the model is relatively insensitive to the value of the assumed recovery rate.