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Credit Spread Changes within Switching Regimes

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Author Info
Olfa Maalaoui
Georges Dionne
Pascal François

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Abstract

Many empirical studies on credit spread determinants consider a single-regime model over the entire sample period and find limited explanatory power. We model the credit cycle independently from macroeconomic fundamentals using a Markov regime switching model. We show that accounting for endogenous credit cycles enhances the explanatory power of credit spread determinants. The single regime model cannot be improved when conditioning on the states of the NBER economic cycle. Furthermore, the regime-based model highlights a positive relation between credit spreads and the risk-free rate in the high regime. Inverted relations are also obtained for some other determinants.

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Paper provided by CIRPEE in its series Cahiers de recherche with number 0905.

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Date of creation: 2009
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Handle: RePEc:lvl:lacicr:0905

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Related research
Keywords: Credit spread; switching regimes; market risk; liquidity risk; default risk; credit cycle; NBER economic cycle;

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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