Corporate Credit Spreads Research Articles

A New Preferred Habitatt Yield Curve Parameter

Since the GFC, the supply of US government bonds has grown significantly, involving large changes in the structure of Treasury debt. This has important implications because many investment funds target duration to immunize their liabilities, incentivised by shortfall risks and new legislation. This paper tries to incorporate these quantity and duration effects into existing term structure models using a new 4-factor decomposition comprising level, slope, curvature and position of the hump (D*) in the yield curve along the maturity/duration axis. D* is measured using US data to create a monthly time-series 1946-2015. This averages 6¼ years, with a 10-month standard deviation. In the absence of more granular data, this series may relate to the preferred habitat of investors and serve as another measure of their risk appetite, where low D* equates to high risk aversion. D* is a statistically significant predictor of economic activity and corporate credit spreads around one-year ahead and it allows a different interpretation of the 2007/08 Financial Crisis and Great Recession.

Monetary Policy, Real Activity, and Credit Spreads: Evidence from Bayesian Proxy SVARs

In this paper, we develop a Bayesian framework to estimate a proxy structural vector autoregression to identify monetary policy shocks. We find that during the Great Moderation period, monetary policy shocks induce a persistent decline in real activity and tightening in financial conditions. Central to this result is a systematic component of monetary policy characterized by a direct and economically significant reaction to changes in corporate credit spreads. The failure to account for this endogenous reaction induces an attenuation in the response of all variables to monetary shocks, a result that also applies to the narrative identification of Romer and Romer (2004). (JEL C32, E23, E32, E44, E52, E58)

Monetary Policy, Real Activity, and Credit Spreads: Evidence from Bayesian Proxy SVARs

This paper studies the interaction between monetary policy, financial markets, and the real economy. We develop a Bayesian framework to estimate proxy structural vector autoregressions (SVARs) in which monetary policy shocks are identified by exploiting the information contained in high frequency data. For the Great Moderation period, we find that monetary policy shocks are key drivers of fluctuations in industrial output and corporate credit spreads, explaining about 20 percent of the volatility of these variables. Central to this result is a systematic component of monetary policy characterized by a direct and economically significant reaction to changes in credit spreads. We show that the failure to account for this endogenous reaction induces an attenuation bias in the response of all variables to monetary shocks.

Interest Rates and Credit Spread Dynamics

Corporate credit spreads narrow when the general level of rates is high, but the effect appears to go well beyond what can be justified by firm-specific and marketwide credit conditions. In this article, the authors argue that the phenomenon is largely a statistical artifact caused by failure to take account of cointegration between Treasury and corporate yields. Using a generalized impulse-response approach and conditioning on the current level of rates, they find that large shocks to the Treasury curve do not produce significant changes in credit spreads, either contemporaneously or out to three years in the future. Among other things, this empirical result calls into question assumptions commonly made in theoretical models of corporate credit risk.

Procyclical Credit Rating Policy

This paper studies whether credit rating agencies applied consistent rating standards to U.S. corporate bonds over the expansion and recession periods between 2002 and 2011. Based on estimates of issuing firms’ credit quality from a structural model, I find that rating standards are in fact procyclical: ratings are stricter during an economic downturn than an expansion. As a result, firms receive overly pessimistic ratings in a recession, relative to during an expansion. I further show that a procyclical rating policy amplifies the variation in corporate credit spreads, accounting for, on average, 11 percent of the increase in spreads during a recession. In the cross section, firms with a higher rollover rate of debt, fewer alternative channels to convey their credit quality to the market, and firms that are more sensitive business to economic cycles are more affected by the procyclical rating policy.

Economic links and credit spreads

Abstract Counterparty risk is an important determinant of corporate credit spreads. However, there are only a few techniques available to isolate it from other factors. In this paper we describe a model of financial networks that is suitable for the construction of proxies for counterparty risk. Using data on North American supplier–customer network of public companies, we find that, for each supplier, counterparties’ leverage and option implied volatilities are significant determinants of corporate credit spreads in the period after the 2008–2009 U.S. recession. Our findings are robust after controlling for several idiosyncratic, industry, and market factors.

Financial regulation policy uncertainty and credit spreads in the US

This paper investigates the linear and nonlinear effects of financial regulation policy uncertainty shocks on US macroeconomic aggregates within a Vector Autoregressive (VAR) framework. Financial regulation policy uncertainty (FRPU) is quantified with a news-based index developed by Baker et al. (2013). Particular attention is paid to the reaction of corporate credit spreads to FRPU shocks. The linear VAR results suggest that exogenous increases in the FRPU index trigger increases in the cost of external finance as well as a persistent negative impact on the real economy. By using a nonlinear (Smooth-Transition) VAR model, I then show that these effects are asymmetric over the business cycle, i.e., credit spreads are estimated to rise three times more during recessions than in non-recessionary periods. Importantly, in both the linear and nonlinear models, FRPU shocks account for large shares of the variability of unemployment and credit spreads. My findings are supported by various robustness checks.

Identifying risks in emerging market sovereign and corporate bond spreads

This paper investigates the systematic risk factors driving emerging market (EM) credit risk by jointly modeling sovereign and corporate credit spreads at a global level. We use a multi-regional Bayesian panel VAR model, with time-varying betas and multivariate stochastic volatility. This model allows us to decompose credit spreads and build indicators of EM risks. A key result is that indices of EM sovereign and corporate credit spreads differ because of their specific reactions to global risks (risk aversion, liquidity and US corporate risk). For example, following Lehman's default, EM sovereign spreads ‘decoupled’ from the US corporate market, whereas EM corporates ‘recoupled.’

An empirical analysis of dynamic dependences in the European corporate credit markets: bonds versus credit derivatives

This article provides new evidence on the dynamic dependences of European corporate credit spread in three markets: bond, Credit Default Swap (CDS) and Asset Swap (ASP). Using daily data from 2005 to 2011, we find that credit spread returns are primarily driven by innovations. The intra-market dependence decreases for bond and ASP innovations during the 2007–2009 subprime crisis but increases for CDS due to the increase of counterparty risk. After the summer of 2009, we find a convergence to the precrisis levels. ASP and bond innovations are closely related suggesting that the cash component (bond) dominates the ASP innovations’ behaviour. On the other hand, CDS’s innovations are unrelated to the bonds’ and ASP’s innovations.

Sarbanes-Oxley Act and corporate credit spreads

Stock market reaction suggests that despite improved disclosure and increased accountability, Sarbanes-Oxley Act (SOX) is too costly and not beneficial. Noting that bondholders are likely to reap the many potential benefits of SOX without bearing the brunt of costs, we examine how SOX affected corporate credit spreads to better assess its benefits. SOX has led to a significant structural decline in spreads of at least 27 basis points. Riskier firms (low rating, long maturity, high leverage, and small size) and firms closely related to SOX major provisions (earning variability, managerial trading, and corporate governance) experience greater declines in spreads.

On credit frictions as labor–income taxation

This paper suggests that a model in which firms face credit constraints on hiring labor can explain both the behavior of the labor wedge and the “jobless recoveries” phenomenon of the last three recessions. Using the corporate credit spread as a measure of firms’ credit conditions, I show that the “jobless recoveries” of the U.S. economy from the last three recessions were associated with slow declines in the spread following those recessions. The credit conditions of firms, thus, were important in shaping the labor market recoveries of the last two decades.

On Credit Frictions as Labor-Income Taxation

This paper suggests that a model in which firms face credit constrains on hiring labor can explain both the behavior of the labor wedge and the “jobless recoveries” phenomenon of the last three recessions. Using the corporate credit spread as a measure of firms’ credit conditions, I show that the “jobless recoveries” of the U.S. economy from the last three recessions were associated with slow declines in the spread following those recessions. The credit conditions of firms, thus, were important in shaping the labor market recoveries of the last two decades.

Sovereign Default Concentration Risk Mitigationin Global Bond Indices

This article reviews the fundamental shift in the market perception of risk factors in fixed-income investments. The sovereign spread risk has increased substantially in recent years and contributes an even bigger portion than corporate credit spread in some investment universes, like euro treasury fixed-income indices. The major drivers of sovereign spread include economic and financial systematic factors and issuer-specific solvency factors. The concentration of sovereign risk has become a critical concern to the investors in the investment of global treasury securities. This article reports major testing results using an in-house intensity-based sovereign default risk model. The model has been used to evaluate the diversification effect of weighting mechanisms using GDP and fiscal strength as risk indicators. <b>TOPICS:</b>Fixed-income portfolio management, VAR and use of alternative risk measures of trading risk, global

Value investing in credit markets

We outline a parsimonious empirical model to assess the relative usefulness of accounting- and equity market-based information to explain corporate credit spreads. The primary determinant of corporate credit spreads is the physical default probability. We compare existing accounting-based and market-based models to forecast default. We then assess whether the credit market completely incorporates this default information into credit spreads. We find that credit spreads reflect information about forecasted default rates with a significant lag. This unique evidence suggests a role for value investing in credit markets.

Identifying Risks in Emerging Market Sovereign and Corporate Bond Spreads

This study investigates the systematic risk factors driving emerging market (EM) credit risk by jointly modelling sovereign and corporate credit spreads at a global level. We use a multi-regional Bayesian panel VAR model, with time-varying betas and multivariate stochastic volatility. This model allows us to decompose credit spreads and to build indicators of EM risks. We find that indices of EM sovereign and corporate credit spreads differ because of their specific reactions to global risk factors. Following the failure of Lehman Brothers, EM sovereign spreads ‘decoupled’ from the US corporate market. In contrast, EM corporate bond spreads widened in response to higher US corporate default risk. We also find that the response of sovereign bond spreads to the VIX was short-lived. However, both EM sovereign and corporate bond spreads widened in flight-to-liquidity episodes, as proxied by the OIS-Treasury spread. Overall, the model is capable of generating other interesting results about the comovement of sovereign and corporate spreads.

Economic Links and Counterparty Risk

Counterparty risk is an important determinant of corporate credit spreads. However, there are only a few techniques available to isolate it from other factors. In this paper we describe a model of financial networks that is suitable for the construction of proxies for counterparty risk. Using data on the U.S. supplier-customer network of public companies, we find that, for each supplier, counterparties’ leverage and jump risk are significant determinants of corporate credit spreads. Our findings are robust after controlling for several idiosyncratic, industry, and market factors.

An Empirical Study of US Corporate Credit Spreads

This paper presents an analysis of the factors that affect US corporate credit spreads. Using data from Bloomberg we investigate the various determinants that cause changes in credit spreads of US corporate firms. As previous research has shown, the variables that should be based on theory determine credit spread changes have limited explanatory power. Our study breaks apart a range of variables into three different sections and analyzes them individual in the groups and together using multiple regressions. We investigate the spot rate, interest rate volatility and slope for the interest rate effects and find strong relationships between spot rate and slope with credit spreads. For the effects of volatility and market uncertainty we find strong relationships between credit spreads and market volatility proxied by VIX and firm volatility proxied by an average of Call and Put implied volatility. TED spreads, SPX and RTY returns show strong relationships between macro-economic variables and credit spreads. Implied default correlations in the Investment Grade and High Yield market also show a strong positive relationship with credit spreads. Our research investigates certain macro-economic variables that have not been researched before and re-establishes previous findings for other variables post-2007 crisis.

Optimal Capital Structure, Corporate Debt Valuation and Credit Spreads under State-Dependent Volatility and Jump Process Asset Dynamics

Optimal Capital Structure, Corporate Debt Valuation and Credit Spreads under State-Dependent Volatility and Jump Process Asset Dynamics

What Segments Equity Markets?

We propose a new, valuation-based measure of world equity market segmentation. While we observe decreased levels of segmentation in many countries, the level of segmentation remains significant in emerging markets. We characterize the factors that account for variation in market segmentation both through time as well as across countries. Both a country's regulation with respect to foreign capital flows and certain nonregulatory factors are important. In particular, we identify a country's political risk profile and its stock market development as two additional local segmentation factors as well as the U.S. corporate credit spread as a global segmentation factor.

Value Investing in Credit Markets

We outline a parsimonious empirical model to assess the relative usefulness of accounting and equity market based information to explain corporate credit spreads. The primary determinant of corporate credit spreads is the physical default probability. We compare existing accounting-based and market-based models to forecast default, and find that a modified structural model with accounting and market inputs is best able to forecast default and explain cross-sectional variation in credit spreads. We then assess whether the credit market completely incorporates this default information into credit spreads. Interestingly, we find that credit spreads reflect information about forecasted default rates with a significant lag. This evidence is suggestive of a role for value investing in credit markets.