THE RELATIONSHIP BETWEEN CREDIT DEFAULT SWAP SPREADS, BOND YIELDS, AND CREDIT RATING ANNOUNCEMENTS

THE RELATIONSHIP BETWEEN CREDIT DEFAULT SWAP SPREADS, BOND YIELDS, AND CREDIT RATING ANNOUNCEMENTS

John Hull, Mirela Predescu, and Alan White*
Joseph L. Rotman School of Management
University of Toronto
105 St George Street
Toronto, ON M5S 3E6
Canada
e-mail addresses:
hull@rotman.utoronto.ca
mirela.predescu01@rotman.utoronto.ca
awhite@rotman.utoronto.ca
First Draft: September 2002
This Draft: January, 2004

* Joseph L. Rotman School of Management, University of Toronto. We are grateful to
Moody's Investors Service for financial support and for making their historical data on
company ratings available to us. We are grateful to GFI for making their data on CDS
spreads available to us. We are also grateful to Jeff Bohn, Richard Cantor, Yu Du, Darrell
Duffie, Jerry Fons, Louis Gagnon, Jay Hyman, Hui Hao, Lew Johnson, Chris Mann,
Roger Stein, and participants at a Fields Institute seminar, meetings of the Moody's
Academic Advisory Committee, a Queens University workshop, and an ICBI Risk
Management conference for useful comments on earlier drafts of this paper. Matthew
Merkley and Huafen (Florence) Wu provided excellent research assistance. Needless to
say, we are fully responsible for the content of the paper.

Abstract
A company’s credit default swap spread is the cost per annum for protection against a
default by the company. In this paper we analyze data on credit default swap spreads
collected by a credit derivatives broker. We first examine the relationship between credit
default spreads and bond yields and reach conclusions on the benchmark risk-free rate
used by participants in the credit derivatives market. We then carry out a series of tests to
explore the extent to which credit rating announcements by Moody’s are anticipated by
participants in the credit default swap market.