CDS spreads as an independent measure of credit risk

Purpose The creditworthiness of corporates is most visible in credit ratings. This paper presents an alternative credit rating measure independently of credit rating agencies. The credit rating score is based on the CDS market trading. Design/methodology/approach A credit rating score is developed which is a linear function of logarithmized credit default swap (CDS) spreads. This new credit rating score is the first one completely independent of rating agency. The estimated ratings are compared with ratings provided by Fitch Ratings for 310 European and US non-financial corporates. Findings The empirical analysis shows that logarithmized CDS spreads and issuer credit ratings by agencies have a linear relationship. The new credit rating score provides market participants with an alternative risk assessment, which is solely based on market factors, and does not rely on credit rating analysts. The results indicate that our credit rating score is able to anticipate agency ratings in advance. Moreover, the analysis demonstrates that the trading volume has only limited influence in the anticipation of rating changes. Originality/value This study shows a new approach to measure the creditworthiness of firms by analyzing CDS spreads. This is highly relevant for regulation, firm monitoring, and investors