Featured Product

    A Tale of Two Memes: How Gamestop and AMC Impacted the Credit Market

    Hello everyone! This will be the first post in a blog series focusing on applications of quantitative credit data to broader market trends. Having recently joined Moody’s Analytics, this blog will be structured akin to the journey of a learner – along the way, I want to share insights as I discover them, and how to best utilize a world of rich consumer, economic, and corporate credit data to paint a fuller picture of what’s going on. As someone fascinated by the mechanics of the options markets, meme stocks, and stock market bubbles, it seemed fitting to begin this journey there.

    Retail trading is a front-and-center issue in many market participants’ minds, having grown dramatically in recent years due to the emergence of low-or-zero transaction fee retail brokerages like Robinhood. While initially the phenomenon was confined to small, highly concentrated niches, it is indisputable that retail traders have become a substantial force. This influence can be felt market-wide, as potentially one of the drivers of the equity options markets boom post-COVID. However, nowhere can it be felt more strongly than in the new 2021 asset class, “meme stocks”.

    Many still view the trend (and its major epicenters, Gamestop Corporation and AMC Entertainment Holdings Inc.) as temporary price dislocations in the equity markets, driven partly by dedicated online communities like WallStreetBets and by the hedging of equity options market makers. Conversely, both meme favorites have demonstrated a stubborn resilience, with equity prices for both remaining markedly elevated since the first signs of the squeeze. This begs the question – what, if anything, materially changed for both companies?

    A classic short squeeze (as many viewed the initial January 2021 squeeze) does not tend to drag on for months after an initial rapid price increase. Comparing recent price action to the 2008 Porsche-Volkswagen short squeeze or the more recent March 2020 squeeze of Blue Apron, usual short squeeze, we see a stark difference in duration. While in all cases we observe substantial declines in short interest post-squeeze, the Blue Apron and Volkswagen culminating events were brief (lasting days) rather than a protracted battle lasting multiple months. It is hard to explain the current situation as a simple short squeeze.

    Looking at the credit data, we can see a different perspective. For both AMC and Gamestop, the presence of a price-insensitive, loyal shareholder base fundamentally changed the solvency and credit outlook of both firms by allowing them to draw capital from increased equity pricing and sustained interest. This capital injection led to creation of fundamental value, improving debt structure, creditworthiness, and reducing default risk dramatically. While many discount these squeezes as one-off events, I argue that the advent of retail trading and social media-driven investing creates a novel factor in understanding future credit risk, especially in the context of heavily shorted and indebted companies (which tend to be retail favorites). This can be used by both short sellers and yield-seeking investors to better model risk and find asymmetric return opportunities.

    Equity and Defaults

    It is well-known that the market capitalization of a firm must reflect implicitly the likelihood that a firm will default in the future. During a default, shareholder equity becomes worthless (although in some cases after reorganization shareholders can negotiate some positive value in the recapitalization). In 1974, Robert Merton provided the key realization that due to limited liability, if a firm is underwater on debt, shareholders can choose to simply liquidate the firm rather than pay back debt. From that perspective, the equity value of a firm can be viewed as a call option on the firm’s assets, with the option for the shareholders to liquidate if debt exceeds asset value (the option expires out-of-the-money) or not liquidate (the option expires in-the-money and is exercised).

    This core thesis underpins how to quantitatively model defaults, best summarized as an Expected Default Frequency (EDF). Prior research using the EDF9 Model (derived from the Merton model) has supported the tacit link between equity valuation and default frequency, with significant excess returns noted for firms with lower probabilities of default than riskier firms.

    From this, we can observe that equity markets, despite potentially uninformed or faddish trading, over the medium-term should reflect credit market information. All things otherwise held similar, the greater liquidity and smaller notional size involved in equity markets implies greater investor accessibility, and investors can often express their credit outlooks more rapidly and easily via equity versus credit. An extreme example of this should occur for companies near to a credit event – as a company approaches default or bankruptcy, it should see precipitous declines in stock price, with the converse (e.g. a rescue package or cancellation of debt) also holding true.

    Interestingly, the relationship between EDF and equity returns tends to be smile-shaped: poor equity performers have higher credit risk, but firms with highly positive equity performance also exhibit heightened default risk, likely correlating with increased use of debt leverage.

    However, this relationship is not unidirectional, as we can see strongly for both AMC and Gamestop. For both meme stocks, the rapid increase in equity price and interest allowed them to raise substantial capital via offerings, materially impacting their ability to service debt and avoid insolvency. Although pre-squeeze most investors discounted both firms as eventual casualties of the macro changes driven by the COVID-19 pandemic, using EDF data, we can see both companies underwent dramatic shifts in credit risk.

     

    Per our EDF model, the 1-year forward chance of default for Gamestop Corporation peaked around May 2020 at nearly 20% (nearly 1200% higher than in 2018). While since then the default point (the time-weighted value of Gamestop’s outstanding debts) remained largely constant, as asset value increased during the squeeze its market leverage (asset value versus default point) markedly decreased while asset volatility (the volatility of the dollar value of Gamestop’s assets) increased.

    Lorem ipsum dolor sit amet, consectetur adipiscing elit. Proin semper at nisi sed bibendum. Phasellus purus magna, ullamcorper vel nibh vel, cursus tempus dolor. Pellentesque nec consequat lectus. Phasellus eu velit rutrum, interdum tortor in, dictum velit. Proin vitae dictum massa. Vivamus ultrices malesuada ligula mollis elementum. Mauris molestie eros felis, et commodo mi viverra vitae. Ut ut sem ex. Sed fringilla ipsum sed diam commodo, sit amet interdum odio facilisis. Nulla suscipit enim quis elit bibendum, vel sollicitudin dolor tempus. Fusce vitae porttitor ex. Pellentesque faucibus orci a faucibus scelerisque. Nunc auctor at tellus non efficitur. Integer vulputate vehicula nunc, vitae convallis orci pulvinar et. Etiam pretium nulla varius sem lobortis, auctor vestibulum nisi rhoncus. Suspendisse in urna at lectus eleifend finibus.

    Maecenas varius mattis turpis, non blandit ex sollicitudin sagittis. Etiam porttitor libero eget odio ornare tristique. Quisque lacinia posuere diam, ac rutrum lacus sollicitudin vel. Etiam rhoncus dignissim hendrerit. Nullam finibus, risus quis pellentesque scelerisque, nulla lorem convallis purus, eget gravida elit elit sit amet nunc. Quisque consectetur orci dolor, ac vehicula eros varius vel. Vestibulum a mattis dolor. Suspendisse mollis malesuada condimentum. Sed vel augue vel tellus commodo consectetur sed finibus leo. Donec sit amet congue arcu.

    Cras et nunc velit. Fusce sollicitudin rhoncus magna, ut tempor libero sagittis sit amet. Cras eu orci eleifend, pulvinar velit et, mollis nisl. Morbi ac ultrices ex. Sed in urna molestie, ultrices mi vitae, interdum dui. Praesent congue lobortis mi, fringilla lacinia ante ultrices sit amet. Nunc enim justo, interdum in rhoncus nec, interdum sed erat.

    Lorem ipsum dolor sit amet, consectetur adipiscing elit. Nunc congue pretium mi, ut elementum nisi rhoncus a. Vestibulum ante ipsum primis in faucibus orci luctus et ultrices posuere cubilia curae; Nulla a risus sodales, sagittis nisi nec, maximus massa. Suspendisse scelerisque suscipit dui in facilisis. Vivamus eleifend, enim in viverra molestie, lorem ante sagittis felis, non dapibus risus magna nec ligula. In non ultricies leo, et congue leo. Pellentesque erat ante, scelerisque bibendum bibendum eu, varius id lectus. In hac habitasse platea dictumst. Mauris mi nisi, egestas quis lorem facilisis, consequat congue odio. Quisque ut nisi sed sem vehicula lobortis. Maecenas egestas ullamcorper lectus, sit amet sollicitudin dolor. Sed tristique urna sagittis ullamcorper vehicula.

    Sed ipsum augue, aliquet at odio in, sollicitudin fermentum elit. In sed dolor egestas, commodo ante sed, vulputate enim. Nam viverra eget lectus nec commodo. In ut sodales metus. Suspendisse laoreet quam quis scelerisque tincidunt. Phasellus venenatis tempor tellus, in dictum neque bibendum non. Donec eget sapien varius, ultrices metus eu, pulvinar risus. Donec et ullamcorper ligula. Mauris iaculis purus massa, a aliquet quam porta vitae. In hac habitasse platea dictumst. Sed aliquam erat sit amet lectus congue elementum. Curabitur at orci ac lorem bibendum semper nec in lacus. Cras id mattis velit. Nunc ullamcorper eget mi ac semper. Proin tincidunt vulputate nisl a lacinia.

    Proin venenatis eget arcu ut pretium. Praesent mattis vel lorem eget fringilla. Quisque laoreet, diam ut accumsan ullamcorper, libero ex facilisis tellus, eget posuere nunc erat non leo. Aenean congue a ligula sed euismod. Fusce ultrices in nisl hendrerit malesuada. Cras sed sollicitudin turpis. Nunc imperdiet lectus at aliquam gravida.

    Duis bibendum purus in urna interdum faucibus. Maecenas sit amet convallis diam, ac faucibus purus. Praesent convallis urna feugiat ultricies rutrum. Duis vulputate ante nec sagittis porta. In hendrerit sapien vitae.

    Donec ut neque leo. Vivamus fermentum urna vel augue posuere, ac ultrices mi maximus. Phasellus venenatis auctor justo, in pulvinar ante. Donec aliquet finibus massa iaculis egestas. Class aptent taciti sociosqu ad litora torquent per conubia nostra, per inceptos himenaeos. Suspendisse potenti. Nullam viverra nec metus a sodales. Pellentesque mollis mi sed leo mattis ultricies. Cras et sapien et lectus imperdiet convallis. Pellentesque posuere commodo ante, ultricies aliquet libero ornare vitae. Praesent elementum sapien magna, vitae ultricies risus congue at. Phasellus bibendum, ex non porttitor condimentum, augue ex facilisis sem, imperdiet faucibus diam purus a sapien. Nam elementum quis ipsum ac pellentesque.

    Nunc tellus odio, tristique nec urna non, viverra facilisis nisl. Cras eu massa aliquam, laoreet mauris nec, eleifend quam. Nullam dictum, tortor ac rutrum molestie, dui augue fermentum neque, nec suscipit enim turpis ut nunc. Maecenas consectetur turpis sit amet facilisis luctus. Donec posuere mi quis aliquet feugiat. Fusce ac ex vel ex ultrices tempus quis in odio. Quisque eget massa placerat, tempus lacus malesuada, scelerisque augue. Aliquam ullamcorper ante in tellus ultrices, eu consequat diam lacinia. Pellentesque et ipsum leo. Fusce sem quam, vestibulum vitae tincidunt ullamcorper, vulputate vel sapien. Pellentesque est lorem, feugiat sed sem at, tincidunt varius ipsum. Nunc egestas consectetur interdum.

    Praesent vestibulum nunc in mi pulvinar, eget eleifend eros tristique. Proin ac leo sapien. Curabitur tincidunt molestie arcu nec venenatis. Maecenas porttitor lorem et nisi porttitor dapibus. Sed aliquam feugiat tellus, id sodales lacus imperdiet at. Suspendisse id quam aliquet, gravida enim vitae, finibus elit. Mauris id imperdiet urna. Phasellus placerat id tellus et posuere. Curabitur euismod, ipsum sed ultricies lobortis, orci erat placerat elit, vitae cursus lorem massa eget lorem. Etiam faucibus, erat nec venenatis varius, diam nulla rutrum leo, ac tempor turpis nibh in turpis. Nunc cursus leo ac magna malesuada.

    Nam purus lorem, elementum eget hendrerit in, auctor at sem. Nam sit amet ultrices urna, eget faucibus mauris. Praesent ornare viverra lorem in scelerisque. Donec hendrerit, mi eu aliquet pellentesque, elit lectus mollis turpis, ac iaculis diam diam et metus. Nam non facilisis est, ornare varius quam. Vivamus non sollicitudin nisi, ac fermentum ligula. Phasellus elit elit, congue id blandit dignissim, tempor vitae justo. Nulla sit amet lobortis mi, quis eleifend nibh. In hac habitasse platea dictumst. Sed nec nibh vel lorem cursus auctor in sed eros. Interdum et malesuada fames ac ante ipsum primis in faucibus. Donec consequat lorem condimentum quam sodales condimentum. Suspendisse eu lacus sed ligula sollicitudin maximus.

    Maecenas ut neque arcu. Morbi commodo hendrerit ante ut laoreet. Proin faucibus viverra nisi, sed consequat est scelerisque tincidunt. Mauris eget blandit urna. Etiam sagittis imperdiet lorem, at convallis urna sagittis sed. Suspendisse sit amet lectus ac massa facilisis molestie quis in enim. Donec vehicula neque enim, id molestie quam rutrum a. Quisque faucibus sit amet ex a mattis. Proin cursus viverra sapien, condimentum luctus massa vestibulum at. Cras eu varius erat.

    Donec ullamcorper mollis ultricies. Maecenas bibendum, ex eu cursus feugiat, eros diam sagittis lacus, eu gravida dui odio vitae mi. Nam non mollis ex. Etiam iaculis id risus ac elementum. Donec dignissim massa sed ligula malesuada pulvinar. Lorem ipsum dolor sit amet, consectetur adipiscing elit. Quisque venenatis ante a quam maximus egestas. Maecenas gravida diam in est convallis ullamcorper. Quisque in tempor arcu. Suspendisse potenti. Nam odio nibh, ultricies quis luctus vitae, aliquam a nibh. Donec pretium interdum dolor non bibendum. Vivamus rutrum enim a lacinia convallis. Cras ac lacinia metus.

    Praesent maximus lectus id nisi condimentum, ut dignissim ex egestas. Sed scelerisque sed sem ut dictum. Mauris sit amet quam diam. Vestibulum non augue vehicula, viverra.