The Sensitivity of the CDS Market to Financial Analysts’ Forecast Revisions

Abstract

We examine the impact of analysts’ earnings per share (EPS) and cash flow per share (CPS) forecast revisions on the market for credit default swaps. Earnings and cash flows directly affect the level of firm assets and equity, and prior theoretical and empirical work demonstrates they are important factors in the determination of credit spreads. Accordingly, if analysts’ forecasts and forecast revisions represent new and unexpected information, credit default swap (CDS) spreads are likely to respond. We find that while the issuance of both EPS and CPS forecast revisions relate inversely with changes in CDS spreads, cash flow forecast revisions have a larger effect, on average. We also find that the relationship between CPS forecast revisions and CDS spreads tends to be stronger in cases of financial distress. Furthermore, we do not observe an immediate significant reaction in the CDS market to analysts’ recommendation changes. Our study provides evidence that cash flow forecasts dominate earnings forecasts in some situations and that participants in the CDS market discriminate between forms of analyst output.