Koresh Galil

THE DETERMINANTS OF CDS SPREADS

This study proposes models that can be used as shorthand analysis tools for CDS spreads and CDS spread changes. For this purpose we examine the determinants of CDS spreads and spread changes on a broad database of 718 US firms during the period from early 2002 to early 2013. Contrary to previous studies, we discover that market variables still have explanatory power after controlling for firm-specific variables inspired by structural models. Three explanatory variables appear to overshadow the other variables examined in this paper: Stock Return, ∆Volatility (the change in stock return volatility) and ∆MRI (change in the median CDS spread in the rating class). We also discover that models used in the event study literature to explain spread changes can be improved by using additional market variables. Further, we show that ratings explain cross-section variation in CDS spreads even after controlling for structural model variables.

Using Merton Model: An Empirical Assessment of Alternatives

Merton (1974) suggested a structural model for default prediction which allows using timely information from the equity market. The literature describes several specifications to the application of the model, including methods presumably used by practitioners. However, recent studies demonstrate that these methods result in inferior estimates compared to simpler substitutes. We empirically examine various specification alternatives and find that the prediction goodness is only slightly sensitive to different choices of default barrier, whereas the choice of assets expected return and assets volatility is significant. Equity historical return and historical volatility produce underbiased estimates for assets expected return and assets volatility, especially for defaulting firms. Acknowledging these characteristics we suggest specifications that improve the model accuracy.

Rating Shopping and Rating Inflation in Israel

The collapse of structured bond ratings during the 2007-2008 financial crisis called attention to the possibility of rating inflation due to lowered rating standards and rating shopping. Nevertheless, little empirical evidence has been offered for this prospect. The Israeli corporate credit rating market serves as solid ground for investigating this matter. In this study, we use data on corporate bond ratings assigned by two local rating agencies affiliated with S&P and Moody’s during the period 2004-2009. We show that while one agency (Midroog) systematically assigned higher ratings, the ratings of the other agency (S&P-Maalot) were inflated due to rating shopping. These conclusions are based on several findings: the presence of selection bias in dual ratings, the superior accounting features of firms rated by S&P-Maalot relative to those similarly rated by Midroog, and the greater tendency of single ratings by S&P-Maalot to be downgraded. We confirm the predictions of recent theoretical studies that rating inflation may occur even when the value of the rating agencies derives from their reputation.Firms may exploit the option of choosing among different rating agencies in order to pick the highest rating offered. This possibility, known as rating shopping, is relatively limited on the US corporate bond market because the two main rating agencies (S&P and Moodys) rate virtually all large bond issuers. In this study, we use the data on corporate bond ratings assigned by two Israeli rating agencies affiliated with S&P and Moodys during the period 2004–2012. We show that while one agency (Midroog) systematically assigned higher ratings, the ratings of the other agency (S&P-Maalot) were inflated due to rating shopping. However, despite the many features that encourage rating inflation, the resulting distortion was relatively small (one notch). This may be a fair price for maintaining a competitive rating industry.

A reexamination of value creation through strategic alliances

This paper uses a sample of 335 firms participating in strategic alliances in order to re-examine the value creation through strategic alliances. We show that the immediate positive response of stock markets to new strategic alliances is followed by negative abnormal returns. Twenty days after announcements, cumulative positive abnormal return is only evident for the firms with the highest stock market’s response to the announcement. We relate the positive abnormal returns reported in previous research to the presence of short-run over-reaction in stock markets and conclude in the market’s ability to identify the more valuable alliances.

Debt composition and lax screening in the Israel corporate bond market

Corporate bond markets may suffer from investors’ lack of competence in screening out low-quality issuers. We use data from the Israeli capital market in 1999–2009 to investigate the quality of corporate bond issuers and the role of the institutional investors in the screening process in the corporate bond market. The findings suggest that higher quality firms were more likely to issue bonds, but firms of lower quality tended to raise a higher fraction of their debt through bond issuance. Firms with higher proportion of their debt in bonds out had also a higher tendency to default. Institutional investors intensively funded firms with higher share of bonds in their long-term debt despite their lower quality, and therefore were partially responsible for the lax screening in the corporate bond market.

Predicting Default More Accurately: To Proxy or Not to Proxy for Default?

Previous studies targeting accuracy improvement of default models mainly focused on the choice of the explanatory variables and the statistical approach. We alter the focus to the choice of the dependent variable. We particularly explore whether the common practice (in literature) of using proxies for default events (bankruptcy or delisting) to increase sample size indeed improves accuracy. We examine four definitions of financial distress and show that each definition carries considerably different characteristics. We discover that rating agencies effort to measure correctly the timing of default is valuable. In predicting default and in explaining CDS spreads, a default model significantly outperforms any other type of financial-distress model, despite being estimated on a substantially smaller sample (72 defaults compared to 409 bankruptcies and 923 delistings).

Is the Morningstar Rating System Global? Evidence from Israel

This study examines ratings of Israeli mutual funds specializing in the major stock indices during the December 2003–April 2007 period. They authors compare the predictive abilities of ratings provided by a local rating agency (S&P-MAALOT) with those of a Morningstar-type rating system and other alternatives. They show that the ratings of the commercial models (Morningstar and S&P-MAALOT) outperform the ratings of conventional measures (Sharpe, Jensen, and mean) and that the difference between the commercial models is statistically insignificant, despite the relative simplicity of the Morningstar model.

Unobserved Heterogeneity and the Term-Structure of Default

This paper estimates the conditional hazard baseline (term-structure) of the hazard rate to default at the time of bonds’ issuance by using two hazard models–one ignoring and another allowing unobserved heterogeneity (UH) in the hazard rate. Following Diamond (1989) one can predict a declining hazard rate to default due to adverse selection and moral hazard. After controlling for UH caused by adverse selection and time-series shocks, the hazard rate shows to be increasing over time and hence the moral hazard effect cannot be confirmed.