numero 2 anno 2013 - CCIAA di Catanzaro - Camera di Commercio

Box 2: “Exploring the relationship between CDS and rating announcements: a literature
review and future research directions”
I risultati di un lavoro di ricerca, svolto da un team di studiosi dell’Ateneo catanzarese - Prof.ssa Annarita Trotta e dott.
sse Rosella Carè e Giusy Cavallaro, dal titolo “Exploring the relationship between CDS and rating announcements:
a literature review and future research directions” sarà presentato al convegno internazionale: “3rd International
Conference on Economics and Finance”. Izmir (Turchia) - 26-27 aprile, 2013 - http://www.icefconference.net/
Di seguito, un abstract della ricerca:
Credit derivatives, and in particular the category of CDS, present some interesting features, which allow an analysis
of how the public and private information affects the market prices. In particular: i) the CDS spreads represent the
direct prices of credit risk (Galil et al., 2011), ii) CDSs are by far the most liquid instrument in the family of credit
derivatives, iii) the increasing harmonization of CDS contracts allows a direct comparison (Cossin et al., 2006). The
growing interest of the literature towards the credit derivatives market is due, therefore, to the characteristics of these
contracts that make them potentially more efficient than other financial instruments in establishing the “right” price
of credit risk (Di Cesare, 2006). For this reason, researchers have begun to explore the relationship between credit
default swap (CDS) and rating announcements. Over the last decade it is possible to find in the literature an interesting
number of work focused on such topic. Norden and Weber (2004), show the ability of markets to anticipate
changes in the rating and a greater impact in the case in which S&P and Moody’s have operated the variations.
Moreover, the abnormal performance would be influenced by the level of the old rating. Hull et al. (2004) point
out that the CDS market anticipates all three types of negative credit events (downgrade, review for downgrade,
negative outlook). Micu et al. (2006), instead, highlight as all types of rating announcements, whether negative
or positive, have a significant impact on CDS spreads. They argued that the impact is greatest for firms with split
ratings, smallcap firms and firms rated near the threshold of investment grade. Afterwards Norden (2009), show
that the CDS market quickly and accurately incorporates public information and that rating announcements are
particularly informative when informational asymmetries are elevated. Chava et al. (2012) point out that the stock
and bond markets seem to perceive the CDS as a viable alternative to credit ratings. Furthermore, the contribution
of Castellano and Scaccia (2012) appears interesting. In such study CDS quotes and volatilities increase before
negative announcements. The authors, moreover, show that announcements made by CRAs, in most of the cases, do
not seem to convey extra information but simply reflect information already discounted by the market. The results of
this work, at the same time, seem to disclose some changing in the CDS signaling power during the financial crisis.
Over the last ten years an increasing number of researches focused on this topic highlighted the ability of the CDS
market to incorporate new information much faster than the announcements of CRAs. However, despite the attention
paid by scholars on the subject, the existing contributions are still deeply heterogeneous for dataset type and
methodology used. Starting from these considerations, this study aims to discuss the information/predictive ability
of CDS to react to rating announcements through the systematization of the existing contributions in the literature
outlining a comprehensive framework to identify the main issues dealt with, any links and/or common results. The
method used in this work is a process of systematic literature review, based on three stage procedure: data collection,
data analysis and synthesis of the results. The aim of conducting a literature review is to enable the researcher both
to map and to assess the existing knowledge. The systematic nature of such procedure improves the quality of the
review process and the results obtained through the use of this transparent and reproducible method (Tranfield et
al., 2003). The results of our work could provide indications of a prescriptive nature to scholars and policy makers
to assess the credit risk, role of rating agencies, information content of credit derivatives and on the role of CDS in
the financial industry. Credit derivatives, and in particular the category of CDS, present some interesting features,
which allow an analysis of how the public and private information affects the market prices. In particular: i) the CDS
spreads represent the direct prices of credit risk (Galil et al., 2011), ii) CDSs are by far the most liquid instrument
in the family of credit derivatives, iii) the increasing harmonization of CDS contracts allows a direct comparison
(Cossin et al., 2006). The growing interest of the literature towards the credit derivatives market is due, therefore,
to the characteristics of these contracts that make them potentially more efficient than other financial instruments in
establishing the “right” price of credit risk (Di Cesare, 2006). For this reason, researchers have begun to explore the
relationship between credit default swap (CDS) and rating announcements. Over the last decade it is possible to find
in the literature an interesting number of work focused on such topic. Norden and Weber (2004), show the ability of
markets to anticipate changes in the rating and a greater impact in the case in which S&P and Moody’s have operated
the variations. Moreover, the abnormal performance would be influenced by the level of the old rating. Hull et
al. (2004) point out that the CDS market anticipates all three types of negative credit events (downgrade, review for
downgrade, negative outlook). Micu et al. (2006), instead, highlight as all types of rating announcements, whether
negative or positive, have a significant impact on CDS spreads. They argued that the impact is greatest for firms
with split ratings, smallcap firms and firms rated near the threshold of investment grade. Afterwards Norden (2009),
show that the CDS market quickly and accurately incorporates public information and that rating announcements
are particularly informative when informational asymmetries are elevated. Chava et al. (2012) point out that the
stock and bond markets seem to perceive the CDS as a viable alternative to credit ratings. Furthermore, the contribution
of Castellano and Scaccia (2012) appears interesting. In such study CDS quotes and volatilities increase
before negative announcements. The authors, moreover, show that announcements made by CRAs, in most of the
cases, do not seem to convey extra information but simply reflect information already discounted by the market.
The results of this work, at the same time, seem to disclose some changing in the CDS signaling power during the
financial crisis. Over the last ten years an increasing number of researches focused on this topic highlighted the
ability of the CDS market to incorporate new information much faster than the announcements of CRAs. However,
despite the attention paid by scholars on the subject, the existing contributions are still deeply heterogeneous for
dataset type and methodology used. Starting from these considerations, this study aims to discuss the information/
predictive ability of CDS to react to rating announcements through the systematization of the existing contributions in
the literature outlining a comprehensive framework to identify the main issues dealt with, any links and / or common
results. The method used in this work is a process of systematic literature review, based on three stage procedure:
data collection, data analysis and synthesis of the results. The aim of conducting a literature review is to enable the
researcher both to map and to assess the existing knowledge. The systematic nature of such procedure improves the
quality of the review process and the results obtained through the use of this transparent and reproducible method
(Tranfield et al., 2003). The results of our work could provide indications of a prescriptive nature to scholars and
policy makers to assess the credit risk, role of rating agencies, information content of credit derivatives and on the
role of CDS in the financial industry.