CBR Briefing #83

How financial shocks can spread through supply chains

A line chart plotting five-year credit default swap spreads in late 2008 for three companies: Ford, American Axle and Manufacturing, which is a Ford supplier, and Advanced Micro Devices, which has no Ford connection. All three lines start at about zero-point-two-five-percent in October 2008. Ford’s rate rises, nearly reaching one percent in late November. American Axle’s spread fluctuates in a pattern similar to Ford’s. And AMD’s spread holds steady compared to the others.

  • Financial or operating changes, such as missed debt payments, job cuts, and weak earnings, can trigger an increase in companies’ credit risk, which immediately affects the companies’ suppliers and customers, according to a team of researchers including Chicago Booth’s John R. Birge.
  • The researchers examined how such news leads to changes in the credit default swap (CDS) spreads of related companies in a supply chain. They find that when a company experiences an extreme jump in its CDS spread, the spreads of its most important suppliers and customers increase in the same day by 59 and 71 basis points, respectively.
  • For example, when Ford Motor Company reported massive losses, looming layoffs, and drastic spending cuts in its November 2008 earnings report, Ford’s CDS spreads quickly widened, as did spreads for American Axle & Manufacturing, a major Ford supplier, but the changes did not affect Advanced Micro Devices, an unrelated company.

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