Is Bloomberg’s Credit Default Swaps Model Superior in Predicting Defaults?

Abstract

Using new corporate bonds issued by US industrial firms from 2001 to 2020, we compare the performance of S&P’s credit ratings with that of the Bloomberg Model Credit Default Swap (CDS) spread and the Bloomberg Market/Model CDS spread ratio. We find that: (1) while both credit ratings and CDS spread affect nominal yield spreads significantly, Bloomberg Model CDS spreads are timelier than credit ratings in updating credit risk information; (2) with regard to predicting actual defaults of the new bonds, both credit ratings and Bloomberg CDS spread are effective; and (3) S&P investment-grade credit ratings do not have any capability to predict defaults, while the Bloomberg CDS spread is effective in predicting defaults regardless of credit quality. We conclude that the Bloomberg Model CDS spread is a better indicator of default risk than the S&P’s credit rating.