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US Corporate Bond Yield Spread : A default risk debate

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  • Syed Muhammad Noaman Ahmed Shah
  • Mazen Kebewar

Abstract

According to theoretical models of valuing risky corporate securities, risk of default is primary component in overall yield spread. However, sizable empirical literature considers it otherwise by giving more importance to non-default risk factors. Current study empirically attempts to provide relative solution to this conundrum by presuming that problem lies in the subjective empirical treatment of default risk. By using post-hoc estimator approach of Lubotsky & Wittenberg (2006), we construct an efficient indicator for risk of default, by using sample of 252 US non-financial corporate data (2000-2010). On average, our results validate that almost 48% of change in yield spread is explained by default risk especially in recent financial crisis period (2007-2009). Hence, our results relatively suggest that potential problem lies in the ad-hoc measurement methods used in existing empirical literature.

Suggested Citation

  • Syed Muhammad Noaman Ahmed Shah & Mazen Kebewar, 2013. "US Corporate Bond Yield Spread : A default risk debate," Papers 1303.3391, arXiv.org.
  • Handle: RePEc:arx:papers:1303.3391
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    References listed on IDEAS

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    1. Darren Lubotsky & Martin Wittenberg, 2006. "Interpretation of Regressions with Multiple Proxies," The Review of Economics and Statistics, MIT Press, vol. 88(3), pages 549-562, August.
    2. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, September.
    3. Lawrence Fisher, 1959. "Determinants of Risk Premiums on Corporate Bonds," Journal of Political Economy, University of Chicago Press, vol. 67, pages 217-217.
    4. Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
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    6. Tsuji, Chikashi, 2005. "The credit-spread puzzle," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1073-1089, November.
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    13. Tang, Dragon Yongjun & Yan, Hong, 2010. "Market conditions, default risk and credit spreads," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 743-753, April.
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    More about this item

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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