Essays on credit default swaps

Abstract

This dissertation consists of three essays on credit default swaps. The first essay is written with Jung-Soon Hyun, and the second essay and the third essay are written with Frederick Dongchul Oh. The first essay examines whether good and bad news have any asymmetric effect on credit default swap (CDS) spreads by decomposing equity volatility into continuous variation and signed jumps depending on the information. We find that negative jumps affect CDS spreads more significantly and economically than positive jumps even after controlling for other variables related to credit risk. This finding suggests that negative jumps in equity prices would be a credit risk factor of individual firms. Moreover, the effects of jumps on CDS spreads are more pronounced for firms with high leverage ratios and small sizes. Finally, we show that our findings remain intact even when considering the global financial crisis period and different CDS maturity terms. The second essay examines how the introduction of credit default swap (CDS) trading on the debt of individual firms affects corporate payout policy. We find that firms increase payouts to shareholders after the introduction of CDS trading on their debt. This suggests that CDS-referenced firms determine payout policy in response to decreased creditor monitoring rather than apply more conservative policies to avoid renegotiations with tougher CDS-insured creditors. Moreover, the increase in payouts after CDS introduction is more pronounced in firms with smaller institutional ownership and greater bank debt dependency. Finally, we show that firms tend to repurchase stocks rather than increase dividends when they increase payouts after the introduction of CDS trading. The third essay uses patent and credit default swap (CDS) data to examine whether corporate innovation affects credit market valuation. We find that innovation quantity, measured by the number of patents, is negatively associated with CDS spreads. Moreover, the relationship between the quality of innovation and CDS spreads is negative. Both the scientific value (based on patent citations) and economic value (based on stock market reaction) of innovation have a negative effect on CDS spreads, but the effect of economic value is more significant than that of scientific value. Overall, our study suggests that the performance of corporate innovation is reflected in credit market valuation.