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Credit spread determinants: An 85 year perspective

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  • Davies, Andrew
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    Abstract

    This paper estimates a set of credit spread forecasting models using an 85 year history for AAA and BAA corporate bond yield data for the US. Credit spreads are defined as the corporate bond yield less the 20 year yield on US government bonds and are explained by a set of intuitively appealing financial and economic variables. Initial results relate to the application of cointegration techniques to provide long and short run estimates of the key determinants of credit spreads. The analysis is then extended to allow for an unobservable latent variable Markov Switching specification across two separate states. Finally a deterministic regime model based upon an inflation threshold is estimated demonstrating that key causal relationships exist independently across different inflationary environments.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Markets.

    Volume (Year): 11 (2008)
    Issue (Month): 2 (May)
    Pages: 180-197

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    Handle: RePEc:eee:finmar:v:11:y:2008:i:2:p:180-197

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    Web page: http://www.elsevier.com/locate/finmar

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    References

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    1. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
    2. Franses,Philip Hans & Dijk,Dick van, 2000. "Non-Linear Time Series Models in Empirical Finance," Cambridge Books, Cambridge University Press, number 9780521770415, October.
    3. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    4. Charles S. Morris & Robert Neal & Douglas Rolph, 1998. "Credit spreads and interest rates : a cointegration approach," Research Working Paper 98-08, Federal Reserve Bank of Kansas City.
    5. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
    6. Chance, Don M, 1990. " Default Risk and the Duration of Zero Coupon Bonds," Journal of Finance, American Finance Association, vol. 45(1), pages 265-74, March.
    7. Johansen, Soren, 1995. "Likelihood-Based Inference in Cointegrated Vector Autoregressive Models," OUP Catalogue, Oxford University Press, number 9780198774501.
    8. Gregory R. Duffee, 1998. "The Relation Between Treasury Yields and Corporate Bond Yield Spreads," Journal of Finance, American Finance Association, vol. 53(6), pages 2225-2241, December.
    9. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
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    Cited by:
    1. Yinghui Dong & Xue Liang & Guojing Wang, 2012. "Unilateral Counterparty Risk Valuation for CDS Under a Regime Switching Interacting Intensities Model," Asia-Pacific Financial Markets, Springer, vol. 19(4), pages 391-415, November.
    2. Monfort, A. & Renne, J-P., 2011. "Default, liquidity and crises: an econometric framework," Working papers 340, Banque de France.
    3. Mansanet-Bataller, Maria & Chevallier, Julien & Hervé-Mignucci, Morgan & Alberola, Emilie, 2011. "EUA and sCER phase II price drivers: Unveiling the reasons for the existence of the EUA-sCER spread," Energy Policy, Elsevier, vol. 39(3), pages 1056-1069, March.
    4. Maria Mansanet-Bataller & Julien Chevallier & Morgan Hervé-Mignucci & Emilie Alberola, 2010. "The EUA-sCER Spread: Compliance Strategies and Arbitrage in the European Carbon Market," Post-Print halshs-00458991, HAL.
    5. Kalimipalli, Madhu & Nayak, Subhankar & Perez, M. Fabricio, 2013. "Dynamic effects of idiosyncratic volatility and liquidity on corporate bond spreads," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2969-2990.
    6. Chan, Kam Fong & Marsden, Alastair, 2014. "Macro risk factors of credit default swap indices in a regime-switching framework," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 285-308.

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