The Impact of Earnings on the Pricing of Credit Default Swaps

This study evaluates the impact of earnings on firm credit risk as captured by CreditDefault Swaps (CDS). We find that earnings (changes) are negatively correlated withone-year swap premia (changes) after controlling for equity returns but not with longer term premia (changes). We also find that earnings surprises are significantly correlated with one-year CDS premia changes in the short window surrounding preliminaryearnings dates and that absolute earnings surprises are significantly correlated withabsolute one-year CDS premia changes in the short window surrounding SEC filingdates. These results suggest that high earnings convey favorable information about the short-term default risk of firms but not about the long term default risk. We furtherdocument that accruals/cash flow information conveyed by SEC filings providesinformation about long-term credit risk. Furthermore, the empirical results are consistent with structural and hybrid model-driven implications of CDS pricing