Beating Market Expectations and the Pricing of Firms’ Probability of Default

• In Event: Research Paper Session—FARS

Abstract

This study explores the impact of beating analysts' forecasts on investors' perceptions about firms' probability of default. Credit Default Swap (CDS) premium is the compensation required by investors for bearing firms' credit default risk. Sell-side analysts collect and combine market, industry, and firm information to produce stock recommendations, stock price targets and accounting number forecasts. The information contained in their forecasts, both earnings and revenues forecasts, provide additional information to investors to price CDS. The results show that firms that beat analysts' earnings and revenue forecasts have on average a decrease in the CDS premium around the earnings announcement date. This study also documents that the effect is stronger when both signals (beating or missing earnings and revenues forecasts) are consistent. When firms beat (miss) earnings and miss (beat) revenues, the effect of earrings is the dominant signal. All these effects are stronger for firms with high levels of default risk.

Author

• Mauricio Melgarejo, Butler University