CDS pricing and credit rating announcements

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Rating agencies are crucial in global financial markets, assessing the creditworthiness of corporates and sovereigns to mitigate asymmetric information. This analysis explores how information from rating events influences the development of CDS spreads and examines the impact of rating announcements and other observable factors on credit spreads. Utilizing a reduction model, we focus on credit announcements from the major agencies: S&P, Moody's, and Fitch. The dynamics of CDS spreads for European corporates and sovereigns reveal varying predictability of credit rating events. Our findings indicate that CDS spread volatility serves as a more reliable predictor for negative rating announcements than changes in CDS spread levels, particularly in the sovereign and financial sectors. This can be attributed to the heterogeneity and information asymmetry present in different sectors. In investigating the pricing of CDS contracts in Europe, we incorporate credit ratings as an independent variable in the model proposed by Doshi, Jacobs, Ericsson, and Turnbull (2013). Our results highlight the significance of credit rating announcements in CDS pricing, a point of contention for many market participants following the sub-prime and sovereign-debt crises. Additionally, the risk-neutral to physical default probability ratios align with Cvitanić et al. (2011), suggesting that heterogeneity results in varying levels of risk aversion, optimism