Review of Accounting Studies

, Volume 17, Issue 3, pp 572–609 | Cite as

Value investing in credit markets

  • Maria CorreiaEmail author
  • Scott Richardson
  • İrem Tuna


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.


Credit markets CDS Bonds Default prediction 

JEL Classification

G12 G14 M41 



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.


  1. Altman, E. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance, 23, 589–609.CrossRefGoogle Scholar
  2. Arora, N., Bohn, J., & Zhu, F. (2005). Reduced form vs. structural models of credit risk: A case study of 3 models. Journal of Investment Management, 3(4), 43–67.Google Scholar
  3. Asquith, P., Au, A., Covert, T., & Pathak, P. (2010). The market for borrowing corporate bonds. NBER Working Paper No. 16282.
  4. Beaver, W. H. (1966). Financial ratios as predictors of failure. Journal of Accounting Research, 4, 71–102.CrossRefGoogle Scholar
  5. Beaver, W. H., Correia, M., & Mcnichols, M. (2012). Do differences in financial reporting attributes impair the predictive ability of financial ratios for bankruptcy. Review of Accounting Studies. doi: 10.1007/s1114201291867.
  6. Beaver, W. H., Mcnichols, M., & Rhie, J. (2005). Have financial statements become less informative? Evidence from the ability of financial ratios to predict bankruptcy. Review of Accounting Studies, 10, 93–122.CrossRefGoogle Scholar
  7. Ben Dor, A., Dynkin, L., Hyman, J., Houweling, P., Van Leeuwen, E., & Penniga, O. (2007). DTS (duration times spread). The Journal of Portfolio Management, Winter, pp. 77–100.Google Scholar
  8. Bessembinder, H., Maxwell, W., & Venkataraman, K. (2006). Market transparency, liquidity externalities, and institutional trading costs in corporate bonds. Journal of Financial Economics, 82, 251–288.CrossRefGoogle Scholar
  9. Bharath, S., & Shumway, T. (2008). Forecasting default with the Merton distance to default model. Review of Financial Studies, 21, 1339–1369.CrossRefGoogle Scholar
  10. Campbell, J., Hilscher, J., & Szilagyi, J. (2008). In search of distress risk. Journal of Finance, 63, 2899–2939.CrossRefGoogle Scholar
  11. Chava, S., & Jarrow, R. (2004). Bankruptcy prediction with industry effects. Review of Finance, 8, 537–569.CrossRefGoogle Scholar
  12. Chen, N., Roll, R., & Ross, S. A. (1986). Economic forces and the stock market. The Journal of Business, 59, 383–403.CrossRefGoogle Scholar
  13. Collin-Dufresne, P., Goldstein, R. S., & Martin, J. S. (2001). The determinants of credit spread changes. Journal of Finance, 56(6), 2177–2207.CrossRefGoogle Scholar
  14. Crosbie, P. J., & Bohn, J. R. (2003). Modeling default risk. San Francisco, CA: KMV, LLC.Google Scholar
  15. Crouhy, M., Galai, D., & Mark, R. (2000). A comparative analysis of current credit risk models. Journal of Banking & Finance, 24, 59–117.CrossRefGoogle Scholar
  16. Dickey, D. A., & Fuller, W. A. (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American Statistical Association, 74, 427–431.Google Scholar
  17. Edwards, A. E., Harris, L. E., & Piwowar, M. S. (2007). Corporate bond market transaction costs and transparency. Journal of Finance, 62, 1421–1451.CrossRefGoogle Scholar
  18. Fama, E., & French, K. (1992). The cross-section of expected stock returns. Journal of Finance, 47, 427–465.CrossRefGoogle Scholar
  19. Fama, E., & French, K. (1993). Common risk factors in the returns of stocks and bonds. Journal of Financial Economics, 33, 3–56.CrossRefGoogle Scholar
  20. Fama, E., & Macbeth, J. (1973). Risk, return and equilibrium: empirical tests. Journal of Political Economy, 81(3), 607–636.CrossRefGoogle Scholar
  21. Hillegeist, S., Keating, E., Cram, D., & Lundstedt, K. (2004). Assessing the probability of bankruptcy. Review of Accounting Studies, 9, 1573–7136.CrossRefGoogle Scholar
  22. Huang, J.-Z., & Huang, M. (2003). How much of the corporate treasury yield spread is due to credit risk? A new calibration approach. Available at SSRN: or
  23. International Swaps and derivatives association, Inc. (2010). ISDA Market Survey.
  24. Jegadeesh, N. (1990). Evidence of predictable behavior of security returns. Journal of Finance, 45, 881–898.CrossRefGoogle Scholar
  25. Kealhofer, S. (2003a). Quantifying credit risk I: Default prediction. Financial Analysts Journal, 59(1), 30–44.CrossRefGoogle Scholar
  26. Kealhofer, S. (2003b). Quantifying credit risk II: Debt valuation. Financial Analysts Journal, 59(3), 78–92.CrossRefGoogle Scholar
  27. Lewellen, J. (2010). Accounting anomalies and fundamental analysis: An alternative view. Journal of Accounting and Economics, 50, 455–466.CrossRefGoogle Scholar
  28. Lok, S., & Richardson, S. (2011). Credit markets and financial information. Review of Accounting Studies, 16, 487–500.CrossRefGoogle Scholar
  29. Merton, R. (1974). On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance, 29, 449–470.Google Scholar
  30. Newey, W. K., & West, K. D. (1987). A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica, 55(3), 703–708.CrossRefGoogle Scholar
  31. Nissim, D., & Penman, S. H. (2001). Ratio analysis and equity valuation: From research to practice. Review of Accounting Studies, 6, 109–154.CrossRefGoogle Scholar
  32. Ohlson, J. (1980). Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research, 18, 109–131.CrossRefGoogle Scholar
  33. Schaefer, S., & Strebulaev, I. (2008). Structural models of credit risk are useful: Evidence from hedge ratios on corporate bonds. Journal of Financial Economics, 90, 1–19.CrossRefGoogle Scholar
  34. Schultz, P. (2001). Corporate bond trading costs: A peek behind the curtain. Journal of Finance, 56, 677–698.CrossRefGoogle Scholar
  35. Securities Industry and Financial Markets Association. (2010). Outstanding U.S. Bond Market Debt Spreadsheet.
  36. Shumway, T. (2001). Forecasting bankruptcy more accurately: A simple hazard model. Journal of Business, 74, 101–124.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2012

Authors and Affiliations

  1. 1.London Business SchoolLondonUK

Personalised recommendations