New Evidence on the Determinants of Credit Spread Changes

Abstract

This paper reexamines determinants of changes in the corporate bond yield spread, using transaction-based data on prices of US corporate bonds from the Trade Reporting and Compliance Engine (TRACE) over the period 2002-2009. We identify a new liquidity measure that has a significant and robust power in explaining corporate bond spread changes and more importantly that outperforms the existing corporate bond liquidity measures. We also show that once credit risk is controlled for, the explanatory power of liquidity is actually reduced in the crisis period, especially for financial firms. On the other hand, we find that the impact of credit risk variables increases substantially for both industrial and financial firms in the periods of crisis. Still, credit risk and liquidity variables together can explain only 35-40% of credit spread changes. As such, the puzzle documented by Collin-Dufresne, Goldstein, and Martin (2001) is still a puzzle.