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

In <ext-link><bold><italic>Is Bloomberg’s Credit Default Swaps Model Superior in Predicting Defaults?</italic></bold></ext-link> from the Winter 2024 issue of <bold><italic>The Journal of Fixed Income</italic></bold>, <bold>Seung Hun Han</bold> of the <bold>KAIST College of Business</bold>, <bold>Karyl Leggio</bold> of <bold>Loyola University</bold>, and <bold>Yoon Shin</bold> of <bold>Loyola University</bold> conclude that Bloomberg’s 5-year model credit default swap (CDS) spreads are a better indicator of corporate (industrial) default risk than Standard & Poor’s credit ratings. The 5-year model CDS spreads particularly outperform in predicting defaults of investment grade–rated corporate bonds, for which S&P credit ratings provide little predictive power. The 5-year model CDS spreads are also timelier. Both credit ratings and the 5-year model CDS spreads are strong indicators of actual corporate bond spreads. The 5-year model CDS spreads are a type of credit risk indicator produced with Bloomberg’s DRSK (default risk) models, along with estimates of default probability and default risk. The authors also examine the ratio of 5-year market spreads to the 5-year model CDS spreads and find that the ratio is not a strong predictor of either default risk or market spreads.