Are Credit Markets Tone Deaf? Evidence from Credit Default Swaps

We examine credit market responses to the linguistic tone of disclosures made in 10-Q/K fillings, controlling for the information content conveyed in the reports. Examining windows around quarterly filings, we find that uncertain tone levels are associated with changes in credit default swap (CDS) spreads and are incremental to price changes implied via equity market responses to the same information. We also observe that the magnitude of the relationship varies according to contract attributes specific to debt, with price responses monotonically increasing as CDS contracts approach maturity and as they approach default. Our results are robust to other sources of risk such as earnings surprises and management guidance, and to alternative proxies of uncertainty and other linguistic dimensions. Our finding is consistent with market participants linking uncertainty in disclosure language to firms' default risk, implying that the tone of accounting disclosures provides valuable incremental information to the CDS markets.