Investor Sentiment and Credit Default Swap Spreads During the Global Financial Crisis

Abstract

This paper examines whether investor sentiment can predict credit default swap (CDS) spread changes. Among several proxies for investor sentiment, change in equity put–call ratio performs best in predicting variation in CDS spread changes in both firm‐ and portfolio‐level regressions; in particular, the explanatory power of this proxy is greater for non‐investment‐grade firms than for investment‐grade firms. More importantly, sentiment may be a critical factor in determining CDS spread changes during the global financial crisis and may best explain the differences in CDS spread in the group of firms whose leverage ratio and stock volatility are highest. © 2016 Wiley Periodicals, Inc. Jrl Fut Mark 37:660–688, 2017

News sentiment and sovereign credit risk

“…2 The most significant variables for CDS spreads have been found to be the US stock market, high-yield spreads and the VIX index. 3 See Georgoutsos and Migiakis (2013), Tang and Yan (2013), Aizenman, Jinjarak, Lee, and Park (2016) and Lee, Kim, and Park (2016). 4 For the classification of developed and less developed countries see Unted Nations (2018).…”

“…See Georgoutsos and Migiakis (), Tang and Yan (), Aizenman, Jinjarak, Lee, and Park () and Lee, Kim, and Park ().…”

Internet Searches, Household Sentiment, and Credit Spreads

“…They find ("positive/optimistic") investor sentiment to be significantly and negatively related to credit spreads, and since investor sentiment is usually negatively correlated with market-wide risk aversion and uncertainty, this result is consistent with the notion that credit spreads depend on investors' risk attitude and on their uncertainty about the future. In another study on sentiment, Lee et al (2017) finds that changes in investor sentiment explains a significant portion of CDS spread changes, even when controlling for traditional structural variables, both on the firm-level and on a portfolio-level. Among the sentiment measures, Lee et al (2017) finds the equity put/call ratio to explain the largest share of the credit spread changes.…”

“…In another study on sentiment, Lee et al (2017) finds that changes in investor sentiment explains a significant portion of CDS spread changes, even when controlling for traditional structural variables, both on the firm-level and on a portfolio-level. Among the sentiment measures, Lee et al (2017) finds the equity put/call ratio to explain the largest share of the credit spread changes. Sentiment seems to be particularly important in turmoil periods and for non-investment grade firms.…”

“…As highlighted by Lee et al (2017), regression analysis on the portfolio-level, for example using indexes, rather than on the firm-level, limits problems with idiosyncratic risk. In addition, while Irresberger et al (2016) focuses on the default sentiment in the US, by collecting US-based Google search volumes, we look at the default sentiment globally, collecting world-wide search volumes and linking these to market-wide CDS spread levels.…”