# Value investing in credit markets

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## Abstract

We outline a parsimonious empirical model to assess the relative usefulness of accounting- and equity market-based information to explain corporate credit spreads. The primary determinant of corporate credit spreads is the physical default probability. We compare existing accounting-based and market-based models to forecast default. We then assess whether the credit market completely incorporates this default information into credit spreads. We find that credit spreads reflect information about forecasted default rates with a significant lag. This unique evidence suggests a role for value investing in credit markets.

## Keywords

Credit markets CDS Bonds Default prediction## JEL Classification

G12 G14 M41## Notes

### Acknowledgments

We are grateful to Jim Ohlson (editor), Itzhak Venezia (discussant), an anonymous referee, seminar participants at the 2011 Citi Global Quantitative Research Conference, 5th LSE/MBS Conference, Kepos Capital LP, London Business School 2011 Accounting Symposium, Moody’s Analytics, NHH, Norges Bank Investment Management, Padova University, State Street Global Markets European Quantitative Forum 2011, Mark Carhart, John Core, Doug Dwyer, Dan Galai, Peter Feldhutter, Erika Jimenez, Partha Mohanram,Tapio Pekkala, Tjomme Rusticus, Pedro Saffi, Stephen Schaefer, Kari Sigurdsson, Richard Sloan, Jing Zhang, and Julie Zhang for helpful discussion and comments. We are especially grateful to Moody’s/KMV for making available a history of point in time EDF data. Any errors are our own.

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