Credit Risk: The Role of Market and Accounting Information-Evidence from U.S. Firms and a FAVAR Model

This paper examines the capability of both accounting and market information in explaining the cross-sectional variation of five-year credit default swap spreads. The paper proposes a panel FAVAR methodological approach to combine the additional predictions from a long list of accounting and market fundamental variables, while controlling the macroeconomic environment of the firms. A comprehensive analysis based on 171 U.S. manufacturing spanning the period 2003 (January)-2011 (October) shows that impulse response functions and variance decompositions support the dominance of the market environment over the accounting environment in providing information to the credit markets, while they display a minor role for the macroeconomic variables employed.