Modeling Credit Spreads: An Application to the Sterling Eurobond Market

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This paper can be considered as a new perspective to analyse credit spreads. We follow a time series approach revealing the forces driving credit spread changes and volatility. Specifically, we aim to identify the process that describes the dynamic evolution of credit spreads on the Sterling Eurobond Index in the period 1991-1999. The time-series properties of credit spreads provide strong evidence of nonlinearities and high levels of intertemporal dependence in the credit spreads generating process. We introduce time-varying volatility models to capture the persistence in the conditional variance of credit spreads. To our knowledge Autoregressive Conditional Heteroskedastic models (ARCH and GARCH) have never been applied to credit spreads.