Effect of policy announcements on US and UK corporate CDS returns during the financial crisis

Pereira, John, Nurullah, Mohamed and Sorwar, Ghulam (2015) Effect of policy announcements on US and UK corporate CDS returns during the financial crisis. In: Behavioural Finance Working Group Conference: Financial Regulation; 11-12 Jun 2015, London, U.K.. (Unpublished)

Abstract

This paper uses event study methodology to investigate the impact of monetary and fiscal policy announcements on corporate CDS returns for both US and UK. We employ a range of parametric and non-parametric tests to access the significance of CDS abnormal returns across a range of narrow event windows. We find interest rate cut announcement has an opposite impact on CDS abnormal return across US and UK, QE announcements leads to higher abnormal returns across both samples and fiscal policy announcements is characterized by small positive gain which is short-lived. Daily CDS returns estimated for each firm and aggregated independently provides us the flexibility to test the differential effect on each subsample grouped on the basis of sector, credit quality, firm size and liquidity. We find the effect of policy announcement is different based on the firm idiosyncratic characteristics and without splitting the sample into sub-categories these effects would have been undetected. By splitting the sample we are able to disentangle this differential effect and note inconsistency across US and UK. We also compare abnormal return dynamics pre and post announcement days and note the median return is mostly higher in the post announcement days for US, while this effect is opposite for the UK sample. This may indicate policy announcements in US were more effective in lowering risk in corporate CDS market than those for UK. We also note the effects of firm idiosyncratic variables are mostly evident for abnormal returns following interest rate cuts and QE announcements, while the effect is least for fiscal policy announcements. Furthermore, we reverse the process and test if a particular policy announcement has a significant effect on firms with certain idiosyncratic characteristics. Overall we note the differences in firm idiosyncratic characteristics is mostly associated with liquidity and gearing for interest rate cut, difference in liquidity and firm size related to QE and firm capitalization related to fiscal policy announcements. We find our results to be robust and consistent for alternative specifications of event windows.

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