Understanding Widening CDS Spreads

In the context of credit derivatives, specifically credit default swaps (CDS), it is important to understand the implications of the CDS spread and its relationship to the creditworthiness of the underlying reference entity. A credit default swap is a financial contract that allows an investor to 'swap' or transfer the credit risk of a reference entity. The CDS spread is the cost of protection and reflects the market's view of the credit risk associated with that reference entity.

Consider the following statements regarding credit default swaps:

1. If the CDS spread for a reference entity decreases, it indicates an improvement in the credit quality of that entity.

2. A higher CDS spread implies that investors are less willing to take on the credit risk associated with the reference entity, reflecting concerns about potential default.

3. If a company’s CDS is trading at a higher spread compared to its peers, this could mean that the market perceives a relative increase in its risk of default.

Based on this information, which of the following interpretations of a widening CDS spread over time would be the most accurate?