Accounting Transparency and the Term Structure of Credit Default Swap Spreads
by Claus Bajlum of Danmarks Nationalbank & Copenhagen Business School, and
August 7, 2007
Abstract: This paper estimates the impact of accounting transparency on the term structure of CDS spreads for a large cross-section of firms. Using a newly developed measure of accounting transparency in Berger, Chen & Li (2006), we find a downward-sloping term structure of transparency spreads. Estimating the gap between the high and low transparency credit curves at the 1, 3, 5, 7 and 10-year maturity, the transparency spread is insignificant in the long end but highly significant and robust at 20 bps at the 1-year maturity. Furthermore, the effect of accounting transparency on the term structure of CDS spreads is largest for the most risky firms. These results are strongly supportive of the model by Duffie & Lando (2001), and add an explanation to the underprediction of short-term credit spreads by traditional structural credit risk models.
Keywords: credit default swaps, structural models, imperfect information.