Enhanced Disclosure of Credit Derivatives, Information Asymmetry, and Credit Risk

• In Event: Even More Financial Reporting

Abstract

This study examines the extent to which enhanced disclosure of credit derivatives (ASC 815-10-50-4 J, K; pre-codification FSP FAS 133-1) reduces information asymmetry. I then investigate the information content of two measures of credit derivative exposure: the maximum payment amount (or total notional principal) of credit derivative exposure and the fair value of credit derivative exposure. I compute the change in average three-day bid-ask effective spreads of our sample banks around 10-K filing dates [(-3,-1) vs. (+1, +3)] for the third quarter of 2008 (the pre FSP 133-1 period) and for the four quarters of 2008 (the post FSP 133-1 period). Then I compare the changes in average daily bid-ask spreads for the two quarters. I find that the difference in the changes in average daily bid-ask spreads, -0.0006, is significantly negative supportive of the information asymmetry reduction argument. I also find that credit derivative sellers have a smaller increase in effective spreads (and analyst forecast dispersion) between pre- and post- periods than a control sample. My study thus provides evidence that the required disclosure has reduced information asymmetry. The reduction in information asymmetry is more pronounced for the credit derivative sellers with lower institutional ownership. In addition, consistent with McAnally (1996), my finding that the maximum payment (notional) amount of credit derivative exposure sold is more credit risk relevant compared to total fair value supports the disclosure requirement regarding the maximum payment amount.

Author

• Qiuhong Zhao, Texas A&M University - Corpus Christi