Credit default swap spread and succession events

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.

Citation

Gonenc, H., Schorer, F. and Appel, W.P.F. (2007), "Credit default swap spread and succession events", Journal of Financial Regulation and Compliance, Vol. 15 No. 4, pp. 450-463. https://doi.org/10.1108/13581980710835281