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Credit spreads and interest rates : a cointegration approach

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  • Charles S. Morris
  • Robert Neal
  • Doug 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.

Suggested Citation

  • Charles S. Morris & Robert Neal & Doug Rolph, 1998. "Credit spreads and interest rates : a cointegration approach," Research Working Paper 98-08, Federal Reserve Bank of Kansas City.
    • Handle: RePEc:fip:fedkrw:98-08
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    File URL: https://www.kansascityfed.org/documents/5278/pdf-rwp98-08.pdf
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    References listed on IDEAS

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    Cited by:

    1. 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, University of Reading.
    2. D. K. Malhotra & Vivek Bhargava & Mukesh Chaudhry, 2005. "Determinants of Treasury-LIBOR Swap Spreads," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 8(04), pages 687-705.
    3. Alejandro Reveiz‐Herault, 2016. "An Active Asset Management Investment Process for Drawdown‐Averse Investors," Intelligent Systems in Accounting, Finance and Management, John Wiley & Sons, Ltd., vol. 23(1-2), pages 85-96, January.
    4. Davide Radi & Vu Phuong Hoang & Gabriele Torri & Hana Dvořáčková, 2021. "A revised version of the Cathcart & El-Jahel model and its application to CDS market," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 44(2), pages 669-705, December.
    5. Alejandro Reveiz Herault, 2008. "The Factor-Portfolios Approach to Asset Management using Genetic Algorithms," Borradores de Economia 511, Banco de la Republica de Colombia.
    6. Nusrat Jahan, 2022. "Macroeconomic Determinants of Corporate Credit Spreads: Evidence from Canada," Carleton Economic Papers 22-07, Carleton University, Department of Economics.
    7. Alejandro Revéiz Hérault, "undated". "Factores determinantes de los márgenes entre bonos del gobierno y bonos corporativos en los Estados Unidos," Lecturas en Finanzas 002710, Banco de la Republica de Colombia.
    8. 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.
    9. Ambrose, Brent W. & Buttimer, Richard Jr., 2005. "GSE impact on rural mortgage markets," Regional Science and Urban Economics, Elsevier, vol. 35(4), pages 417-443, July.
    10. Ericsson, Jan & Reneby, Joel, 2003. "Valuing Corporate Liabilities," SIFR Research Report Series 15, Institute for Financial Research.
    11. Maalaoui Chun, Olfa & Dionne, Georges & François, Pascal, 2014. "Credit spread changes within switching regimes," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 41-55.
    12. Astrid Van Landschoot, 2004. "The Determinants of Credit Spreads," Financial Stability Review, National Bank of Belgium, vol. 2(1), pages 135-155, June.
    13. Alicia Garcia Herrero & Alvaro Ortiz, 2004. "The Role Of Global Risk Aversion In Explaining Latin American Sovereign Spreads," International Finance 0408001, University Library of Munich, Germany.
    14. Fischer, Henning & Stolper, Oscar, 2019. "The nonlinear dynamics of corporate bond spreads: Regime-dependent effects of their determinants," Discussion Papers 08/2019, Deutsche Bundesbank.
    15. Hongming Huang & Yildiray Yildirim, 2008. "Leverage, options liabilities, and corporate bond pricing," Review of Derivatives Research, Springer, vol. 11(3), pages 245-276, October.
    16. Horst Rottmann & Franz Seitz, 2004. "Credit spreads and their determinants in Germany," ifo Schnelldienst, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 57(24), pages 10-14, December.
    17. Davies, Andrew, 2008. "Credit spread determinants: An 85 year perspective," Journal of Financial Markets, Elsevier, vol. 11(2), pages 180-197, May.
    18. Dötz, Niko, 2014. "Decomposition of country-specific corporate bond spreads," Discussion Papers 37/2014, Deutsche Bundesbank.
    19. 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.
    20. Thomas Siegl & Peter Quell, 2004. "Modelling Specific Interest Rate Risk with Estimation of Missing Data," Applied Mathematical Finance, Taylor & Francis Journals, vol. 12(3), pages 283-309.

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    Keywords

    Credit; Interest rates;

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