What Moves CDS Spreads?

When credit default swaps (CDS) spreads change, to what extent can we interpret that the credit risk of the reference entities have changed? We study determinants of CDS spread changes between consecutive trades. Using transactions data for corporate reference entities in North America during 2002-2009, we find that changes in firm-level fundamentals and market conditions are the most significant determinants of CDS spread changes. Supply-demand imbalance for CDS contracts moves CDS spreads, but this effect is transitory if it is not accompanied by tangible information flow. The overall explainable portion of CDS spreads changes, as measured by adjusted R-squared, is about 40% for trade-based price changes. CDS spreads are more sensitive to fundamental variables, especially to macro variables, during the crisis period than the normal period. Among the explained portion of CDS spread changes, two-thirds may be attributed to firm-level and market-wide fundamental variables, and the remaining one-third to supply-demand imbalance and CDS liquidity variables