Inefficient Investments and CDS Premia

• In Event: Research Paper Session—FARS-1

Abstract

This study examines the relation between investment divergence from expected level and CDS premia. The study finds that divergent investments, both overinvestments and underinvestments, have negative impact on their perceived credit risk as reflected in Credit Default Swaps (CDS). The finding suggests that because of agency problems, when managers make “inefficient” investment decisions, their personal interests are in line more with debtholders than with shareholders. This study also suggests that divergent investments affect CDS premia through affecting future financial situations, and that the magnitude of the effects depends on a company’s financial condition.

Authors

• Xiaosi Liu, Kent State University

• Pervaiz Alam, Kent State University - Kent

• Shunlan Fang, Kent State University - Kent