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Determinants of Short-Term Corporate Yield Spreads: Evidence from the Commercial Paper Market

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  • Jing-Zhi Huang
  • Bibo Liu
  • Zhan Shi

Abstract

What drives short-term credit spreads: credit risk, liquidity risk, or both? We investigate this issue using the structural approach to credit risk modeling and a novel data set of secondary market transaction prices for Chinese commercial papers (CPs). In particular, we propose and test a structural model with jump risk and exogenous market illiquidity under which the predicted yield spreads can be decomposed into a credit component and a liquidity component. We find that credit risk and, especially liquidity risk, are important determinants of short-term yield spreads. Our model-based decomposition results show that, on average, credit risk and market liquidity account for about 25% and 52% of CP yield spreads, respectively. For comparison, we also examine the drivers of the US CP yield spreads using security-level data. We find that credit risk accounts for a small fraction of the observed yield spreads but liquidity contributes a much greater proportion.

Suggested Citation

  • Jing-Zhi Huang & Bibo Liu & Zhan Shi, 2023. "Determinants of Short-Term Corporate Yield Spreads: Evidence from the Commercial Paper Market," Review of Finance, European Finance Association, vol. 27(2), pages 539-579.
    • Handle: RePEc:oup:revfin:v:27:y:2023:i:2:p:539-579.
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    File URL: http://hdl.handle.net/10.1093/rof/rfac030
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    More about this item

    Keywords

    Commercial paper; Corporate yield spreads; Corporate debt illiquidity; Jump risk; Credit spread puzzle; Structural credit risk models;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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