Credit default swap spread and succession events
Published date | 20 November 2007 |
Pages | 450-463 |
Date | 20 November 2007 |
DOI | https://doi.org/10.1108/13581980710835281 |
Author | Halit Gonenc,Floris Schorer,Willem P.F. Appel |
Subject Matter | Accounting & finance |
Credit default swap spread
and succession events
Halit Gonenc
Faculty of Economics and Business, University of Groningen, Groningen,
The Netherlands
Floris Schorer
Credit Trading, ING Financial Markets, Amsterdam, The Netherlands, and
Willem P.F. Appel
London, UK
Abstract
Purpose – Credit default swap (CDS) spreads may not represent the accurate credit risk levels
(asymmetric spread behavior) of assets with the initiation of corporate events, such as merger, spin-off
or other similar events in which one entity succeeds to the obligations of another entity. The
International Swaps and Derivatives Association (ISDA) succession language for the definition of
succession events misleads the CDS market participants to determine CDS spreads. The purpose of this
paper is to provide a conceptual framework for the relationship between the ISDA succession language
and CDS spreads in order to clarify the factors behind the asymmetric spread behavior around several
corporate activities.
Design/methodology/approach – The authors develop a conceptual driver model to establish a
link between company characteristics and succession issues. Then, a succession model to evaluate the
risk levels occurring with succession issues is designed.
Findings – The ISDA succession language has an influence on CDS spreads around corporate
events. The explanatory approach provides the foundation for the understanding of the relationships
between succession issues caused by several corporate events, involving particularly restructuring,
refinancing and/or guarantee risk, and CDS spreads. Combination of the driver model and the
succession model helps to assess the potential influence of succession events on CDS spreads.
Research limitations/implications – Market participants should take into consideration the
effects of the ISDA succession language on CDS spreads around succession of CDS.
Originality/value – Prior research related to the CDS has always focused on the economic
determinants of CDS spreads. This paper is the first attempt to explain the relationship between the
ISDA succession language and CDS spreads.
Keywords Risk management,Credit management, Financial analysis
Paper type Conceptual paper
1. Introduction
A credit default swap (CDS) is an over-the-counter derivative and its design includes a
transfer capability of the credit default risk of a corporate borrower among investors.
The first CDS contracts evolved in the late 1990s and in 1999 the International
Swaps and Derivatives Association (ISDA) issued definitions on credit derivatives.
ISDA altered and extended these definitions in 2003.
A CDS gives the participants the opportunity to transfer credit risk without
transferring the underlying credit asset (bond or loan). As a derivative instrume nt, the
advantage of the CDS is to encourage trading the risk of a company’s obligations
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1358-1988.htm
JFRC
15,4
450
Journal of Financial Regulation and
Compliance
Vol. 15 No. 4, 2007
pp. 450-463
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581980710835281
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