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Measuring credit spreads: evidence from Australian Eurobonds

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  • Jonathan Batten
  • Warren Hogan
  • Gady Jacoby

Abstract

Recent theoretical models including the closed-form valuation model of Longstaff and Schwartz (1995) predict that credit spreads are driven by both an asset and interest rate factor. In empirical studies the credit spread may be expressed as either the difference between, or ratio of, the risky bond to a riskless bond. Using a daily sample of non-callable Australian dollar denominated Eurobonds it is found, consistent with theory, that changes in credit spreads are negatively related to both changes in the return on All Ordinaries stock Index and changes in the Government bond yield. Interestingly, the ratio measure - termed a relative credit spread - tends to be statistically more significant than the alternate measure based upon the difference - termed an actual credit spread. However, it is shown that this result is spurious and due to the way in which relative credit spreads are constructed. Noting Duffee's (1998) warning against using callable bonds, the use of only non-callable Eurobonds provides a cleaner result when compared with tests conducted by Longstaff and Schwartz (1995).

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 15 (2005)
Issue (Month): 9 ()
Pages: 651-666

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Handle: RePEc:taf:apfiec:v:15:y:2005:i:9:p:651-666

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References

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  1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
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Cited by:
  1. Chee Jin Yap & Gerard Gannon, 2007. "Factors Affecting the Credit Spreads Behaviour of USD Malaysian Bonds," Accounting, Finance, Financial Planning and Insurance Series 2007_10, Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance.
  2. Silvio Contessi & Pierangelo De Pace & Massimo Guidolin, 2013. "How did the financial crisis alter the correlations of U.S. yield spreads?," Working Papers 2013-005, Federal Reserve Bank of St. Louis.
  3. Gady Jacoby & Chuan Liao & Jonathan A. Batten, 2007. "A Pure Test for the Elasticity of Yield Spreads," The Institute for International Integration Studies Discussion Paper Series iiisdp195, IIIS.

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