Credit Spreads and Incomplete Information

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Credit Spreads and Incomplete Information

by Snorre Lindset of Sør-Trøndelag University College & Norwegian University of Science and Technology,
Arne-Christian Lund of the Norwegian School of Economics and Business Administration, and
Svein-Arne Persson of the Norwegian School of Economics and Business Administration & Sør-Trøndelag University College

May 14, 2008

Abstract: A company’s credit spreads and default policy are analyzed in a structural model of credit risk. Agents have incomplete information about the company’s EBIT (Earnings Before Interest and Taxes) process and observe it with time delays. When all agents observe the state variable with the same delay, the delay has a minor effect on credit spreads and default policy. Asymmetric information occurs when different agents observe the EBIT process with different time delays. Our simple model with neither noisy accounting information nor discrete arrival of information, but with asymmetric information between bondand equity holders, produces qualitatively similar results as Duffie and Lando (2001). Wider credit spreads are obtained in another model where we allow for trade of equity, and where the information asymmetry is between the management and the financial market.

JEL Classification: G12, G33.

Keywords: Credit risk, credit spreads, delayed information, asymmetric information.

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