eThesis - School of Business electronic theses

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PURPOSE OF THE STUDY The purpose of this thesis is to address the limited understanding of the relevance of accounting information to the credit markets. Consequently, using credit default swap (CDS) spreads as a proxy for investors’ perceived default risk, the ultimate aim of the thesis is to find out whether accounting information is in fact a relevant source of information to the credit markets and if so, to what extent. More specifically, the thesis provides a detailed comparative analysis on the abilities of accounting and market information to explain the variation in credit default swap spreads. Furthermore, the thesis offers evidence on the industry effects of accounting data relevance as well as on the effects of the global financial crisis of 2008/10.

DATA The data on European credit default swap spreads for the period reaching from the first quarter of 2005 to the second quarter of 2010 was acquired from Datastream. The necessary accounting and market metrics were obtained from Thomson Worldscope. Data on control variables, namely the risk free interest rate and iTraxx constituent information, was attained from the Bank of Finland’s website and Reuters 3000 Xtra, respectively. The final sample consists of 2 032 firm-quarter observations and it comprises of 155 distinct CDS entities from 10 different sectors and 17 different countries.

RESULTS The results indicate that accounting information is a relevant source of information to the credit markets. It was, however, found that market information is, in accordance with a priori expectations, able to provide more relevant information to the holders of credit derivatives than that which is provided by accounting information. In other words, the market-based regression model is able to explain a larger proportion of the variation in CDS spreads than the accounting-based model. It was furthermore found that accounting information is of incremental relevance which implies that accounting and market information are used in tandem by the CDS markets. Supporting evidence of the existence of industry effects was found while it was similarly witnessed that accounting information relevance decreased in the global financial crisis of 2007-2010.