Impact of credit derivatives on the firm's cost of borrowing: the case of CDS

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School of Business | Master's thesis
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OBJECTIVES OF THE STUDY: The main aim of this thesis is to study whether having an actively traded CDS market for a firm that replies on debt market for external financing would affect the borrowing cost it pays control-ling for credit risk, industrial effects etc. Also as the CDS market develops both organically and through better regulatory oversights whether a more liquid CDS market would have an impact on the firm's cost of borrowing controlling for other factors. This thesis utilises two proprietary data sources that have not been used in similar studies before and applies a regression method that better in taking into account tail impact and outliers which are common in corporate credit mar-ket. DATA: The data in this study covers between May 2010 and March 2014. The firms whose data are analysed, are major industrial companies belonging to either S&P 500 or FTSE 100 Index. The five year generic Asset swap spread, used as the proxy for a firm's cost of borrowing, together with other bond level data, are collected from Bloomberg. CDS liquidity data is collected from Fitch Solution. Firm's credit risk is measured by Kamakura's Probability of Default score, which is a commercial credit risk management product, marketed by Kamakura Inc. and the data is collected from Kamakura. RESULTS: By comparing two groups of firms' cost of borrowing with one group containing firms with an active CDS market and the other one without, controlling for relevant factors, the result suggests a small positive but statistically significant impact of CDS trading on a firm's cost of borrowing. Having an actively traded CDS market marginally reduces how much the firm would have to pay to borrow money in the bond market. This impact is mostly visible during a normal market condition while at extreme market scenarios the relationship breaks down. The relevant interpretation is the existence of the positive impact while the scale of the reduction is rather minimum. At industry level it also suggests that at under most market conditions companies benefit from more liquid CDS market in the form of a slight reduction in borrowing cost after controlling for other factors. Again the absolute scale is small in absolute term.
credit default swaps, cost of borrowing, CDS liquidity, quantile regression
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