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The joint estimation of term structures and credit spreads

  • Houweling, Patrick
  • Hoek, Jaap
  • Kleibergen, Frank

We present a new framework for the joint estimation of the default-free government term structure and corporate credit spread curves. By using a high-quality data set of German mark denominated bonds, we show that this yields more realistic spreads than conventionally obtained spread curves that result from subtracting independently estimated government and corporate term structures. The estimated spread curves are now smooth functions of time to maturity, as opposed to the twisting curves one gets from the traditional method, and are less sensitive to model specifications. Moreover, the implied corporate term structures have tighter confidence intervals.

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File URL: http://www.sciencedirect.com/science/article/B6VFG-435CHG9-4/2/c8a9684bd3d1e7d81a14ee6ce361a4bf
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Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 8 (2001)
Issue (Month): 3 (July)
Pages: 297-323

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Handle: RePEc:eee:empfin:v:8:y:2001:i:3:p:297-323
Contact details of provider: Web page: http://www.elsevier.com/locate/jempfin

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  1. Shea, Gary S., 1984. "Pitfalls in Smoothing Interest Rate Term Structure Data: Equilibrium Models and Spline Approximations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(03), pages 253-269, September.
  2. 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.
  3. Vasicek, Oldrich A & Fong, H Gifford, 1982. " Term Structure Modeling Using Exponential Splines," Journal of Finance, American Finance Association, vol. 37(2), pages 339-48, May.
  4. Gregory R. Duffee, 1994. "On measuring credit risks of derivative instruments," Finance and Economics Discussion Series 94-27, Board of Governors of the Federal Reserve System (U.S.).
  5. 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.
  6. Hull, John & White, Alan, 1995. "The impact of default risk on the prices of options and other derivative securities," Journal of Banking & Finance, Elsevier, vol. 19(2), pages 299-322, May.
  7. 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.
  8. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
  9. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
  10. Litzenberger, Robert H & Rolfo, Jacques, 1984. " An International Study of Tax Effects on Government Bonds," Journal of Finance, American Finance Association, vol. 39(1), pages 1-22, March.
  11. Shea, Gary S, 1985. " Interest Rate Term Structure Estimation with Exponential Splines: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 319-25, March.
  12. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  13. Beim, D.O., 1992. "Term Structure and the Non-Cash Values in Bonds," Papers 92-40, Columbia - Graduate School of Business.
  14. 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.
  15. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
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