Default Risk, Credit Market Liquidity, and Corporate Events

Prior literature examining bond excess returns around corporate events assumes that creditor wealth effects are driven by changes in the default risk of the firm. I revisit these bond event studies using data from 2002 through 2014, explore intra-firm individual bond reactions, and refine the analyses using changes in credit default swap (CDS) spreads. CDS spreads (price-weighted firm aggregate cash bond prices) show small increases (large increases) in default risk of acquiring firms, no change (large increases) for common equity repurchasing firms, and large decreases (no change) for seasoned equity offering (SEO) firms. I isolate liquidity effects around these events by examining changes in the CDS-bond basis and contrast with introduction of the “basis credit ratio” (BCR) comparing basis to cash bond spread changes. Firm aggregate median BCRs show variation in the CDS-bond basis contributes between 50.8% and 69.6% of changes in bond spreads, suggesting that credit market liquidity risk around these corporate events is economically large relative to default risk