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Credit spreads and interest rates : a cointegration approach

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  • Charles S. Morris
  • Robert Neal
  • Douglas Rolph

Abstract

This paper uses cointegration to model the time-series of corporate and government bond rates. We show that corporate rates are cointegrated with government rates and the relation between credit spreads and Treasury rates depends on the time horizon. In the short-run, an increase in Treasury rates causes credit spreads to narrow. This effect is reversed over the long-run and higher rates cause spreads to widen. The positive long-run relation between spreads and Treasuries is inconsistent with prominent models for pricing corporate bonds, analyzing capital structure, and measuring the interest rate sensitivity of corporate bonds.

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File URL: http://www.kansascityfed.org/publicat/reswkpap/PDF/RWP98-08.pdf
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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number 98-08.

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Date of creation: 1998
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Handle: RePEc:fip:fedkrw:98-08

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Keywords: Credit ; Interest rates;

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  1. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
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  7. Hayne E. Leland and Klaus Bjerre Toft., 1995. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Research Program in Finance Working Papers RPF-259, University of California at Berkeley.
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  15. Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
  16. Toru Konishi & Valerie A. Ramey & Clive W.J. Granger, 1993. "Stochastic Trends and Short-Run Relationships Between Financial Variables and Real Activity," NBER Working Papers 4275, National Bureau of Economic Research, Inc.
  17. 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.
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Citations

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Cited by:
  1. Alejandro Revéiz Hérault, 2002. "Factores determinantes de los márgenes entre bonos del gobierno y bonos corporativos en los Estados Unidos," LECTURAS EN FINANZAS 002710, BANCO DE LA REPÚBLICA.
  2. Olfa Maalaoui & Georges Dionne & Pascal François, 2009. "Credit Spread Changes within Switching Regimes," Cahiers de recherche 0905, CIRPEE.
  3. Horst Rottmann & Franz Seitz, 2004. "Credit Spreads und ihre Determinanten in Deutschland," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 57(24), pages 10-14, December.
  4. Davies, Andrew, 2008. "Credit spread determinants: An 85 year perspective," Journal of Financial Markets, Elsevier, vol. 11(2), pages 180-197, May.
  5. Alicia Garcia Herrero & Alvaro Ortiz, 2004. "The Role Of Global Risk Aversion In Explaining Latin American Sovereign Spreads," International Finance 0408001, EconWPA.
  6. Alejandro Reveiz Herault, . "The Factor-Portfolios Approach to Asset Management using Genetic Algorithms," Borradores de Economia 511, Banco de la Republica de Colombia.
  7. Carol Alexandra & Jacques Pezier, 2003. "On the Aggregation of Market and Credit Risks," ICMA Centre Discussion Papers in Finance icma-dp2003-13, Henley Business School, Reading University.
  8. Manzoni, Katiuscia, 2002. "Modeling credit spreads: An application to the sterling Eurobond market," International Review of Financial Analysis, Elsevier, vol. 11(2), pages 183-218.
  9. Hongming Huang & Yildiray Yildirim, 2008. "Leverage, options liabilities, and corporate bond pricing," Review of Derivatives Research, Springer, vol. 11(3), pages 245-276, October.
  10. Ericsson, Jan & Reneby, Joel, 2003. "Valuing Corporate Liabilities," SIFR Research Report Series 15, Institute for Financial Research.
  11. Junji Shimada & Toyoharu Takahashi & Tatsuyoshi Miyakoshi & Yoshihiko Tsukuda, 2010. "Japanese Interest Rate Swap Pricing," TERG Discussion Papers 253, Graduate School of Economics and Management, Tohoku University.

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