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Credit Spreads and the Treasury Zero Coupon Spot Curve

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Author Info

  • Frank Skinner

    ()
    (ICMA Centre, University of Reading)

  • Nicholas Papageorgiou

    (HEC Montreal, Canada)

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    Abstract

    This paper examines the relationship between credit spreads on industrial bonds and the underlying Treasury term-structure. Unlike previous studies, we use zero-coupon spot rates, which eliminate coupon bias, and so allow for a consistent study both within and across the different credit ratings. As far as we are able to determine, we are the first to examine the stability of the relation between credit spreads and the Treasury term structure. We find that the level and the slope of the Treasury term structure are negatively correlated with the spread on corporate bonds. Importantly, the effect of the level and slope of the Treasury yield curve on credit spreads are reasonably constant through time. This is good news for value-at-risk calculations as this suggests that the correlation amongst assets of different credit classes are stable, so use of historic correlations to model spread relations maybe valid.

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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2001-06.pdf
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    Bibliographic Info

    Paper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2001-06.

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    Length: 38 pages
    Date of creation: Aug 2001
    Date of revision: Jul 2002
    Handle: RePEc:rdg:icmadp:icma-dp2001-06

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    Web page: http://www.henley.reading.ac.uk/
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    Related research

    Keywords: Credit Spread; Coupon Bias; Value at Risk; Correlation;

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    References

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    1. Edwin J. Elton, 2001. "Explaining the Rate Spread on Corporate Bonds," Journal of Finance, American Finance Association, vol. 56(1), pages 247-277, 02.
    2. Breusch, T S & Pagan, A R, 1980. "The Lagrange Multiplier Test and Its Applications to Model Specification in Econometrics," Review of Economic Studies, Wiley Blackwell, vol. 47(1), pages 239-53, January.
    3. Gregory R. Duffee, 1996. "Estimating the price of default risk," Finance and Economics Discussion Series 96-29, Board of Governors of the Federal Reserve System (U.S.).
    4. Sarig, Oded & Warga, Arthur, 1989. " Some Empirical Estimates of the Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 44(5), pages 1351-60, December.
    5. Gregory R. Duffee, 1998. "The Relation Between Treasury Yields and Corporate Bond Yield Spreads," Journal of Finance, American Finance Association, vol. 53(6), pages 2225-2241, December.
    6. Mark Fisher & Douglas Nychka & David Zervos, 1995. "Fitting the term structure of interest rates with smoothing splines," Finance and Economics Discussion Series 95-1, Board of Governors of the Federal Reserve System (U.S.).
    7. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-30, June.
    8. McCulloch, J Huston, 1971. "Measuring the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 44(1), pages 19-31, January.
    9. Daniel F. Waggoner, 1997. "Spline methods for extracting interest rate curves from coupon bond prices," Working Paper 97-10, Federal Reserve Bank of Atlanta.
    10. Edwin J. Elton & T. Clifton Green, 1998. "Tax and Liquidity Effects in Pricing Government Bonds," Journal of Finance, American Finance Association, vol. 53(5), pages 1533-1562, October.
    11. Antionio Diaz & Frank Skinner, 2001. "Estimating Corporate Yield Curves," ICMA Centre Discussion Papers in Finance icma-dp2001-01, Henley Business School, Reading University.
    12. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
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