IDEAS home Printed from https://ideas.repec.org/p/boe/boeewp/202.html
   My bibliography  Save this paper

Credit spreads on sterling corporate bonds and the term structure of UK interest rates

Author

Listed:
  • Jeremy Leake

Abstract

In this paper the relationship between credit spreads on sterling corporate bonds and the term structure of UK interest rates is explored. In particular, the question of whether credit spreads are a reliable indicator of corporate bond default risk is examined. Using daily price quotes from 1990 to 1998, a small negative relationship is identified between credit spreads on sterling investment-grade corporate bonds and the level and slope of the term structure of UK interest rates. The results are weaker than those found by some previous studies which examined the relationship between US corporate bond credit spreads and the term structure of US interest rates. The weakness of the relationship suggests that credit spreads on sterling investment-grade corporate bonds have been driven by factors other than default risk. If so, we should be cautious in interpreting such credit spreads as measures of bond default risk. This result is important to both those in the field of financial stability interested in leading indicators of corporate defaults, and to monetary policy makers interested in the impact of interest rate changes on corporate bond default risk. Similar work should be repeated for sterling sub investment-grade corporate bonds once a sufficiently large data set can be assembled.

Suggested Citation

  • Jeremy Leake, 2003. "Credit spreads on sterling corporate bonds and the term structure of UK interest rates," Bank of England working papers 202, Bank of England.
    • Handle: RePEc:boe:boeewp:202
    as

    Download full text from publisher

    File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2003/wp202.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Gregory R. Duffee, "undated". "Treasury Yields and Corporate Bond Yield Spreads: An Empirical Analysis," Finance and Economics Discussion Series 1996-20, Board of Governors of the Federal Reserve System (U.S.), revised 10 Dec 2019.
    3. Scholes, Myron & Williams, Joseph, 1977. "Estimating betas from nonsynchronous data," Journal of Financial Economics, Elsevier, vol. 5(3), pages 309-327, December.
    4. Yawitz, Jess B., 1977. "An Analytical Model of Interest Rate Differentials and Different Default Recoveries," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(3), pages 481-490, September.
    5. 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 449-470, May.
    6. Bierman, Harold & Hass, Jerome E., 1975. "An Analytical Model of Bond Risk Differentials," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 10(5), pages 757-773, December.
    7. Fowler, David J. & Rorke, C. Harvey, 1983. "Risk measurement when shares are subject to infrequent trading : Comment," Journal of Financial Economics, Elsevier, vol. 12(2), pages 279-283, August.
    8. Mark Grinblatt, 2001. "An Analytic Solution for Interest Rate Swap Spreads," International Review of Finance, International Review of Finance Ltd., vol. 2(3), pages 113-149, September.
    9. Edwin J. Elton & Martin J. Gruber & Deepak Agrawal & Christopher Mann, 2001. "Explaining the Rate Spread on Corporate Bonds," Journal of Finance, American Finance Association, vol. 56(1), pages 247-277, February.
    10. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    11. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    12. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
    13. 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.
    14. Kwan, Simon H., 1996. "Firm-specific information and the correlation between individual stocks and bonds," Journal of Financial Economics, Elsevier, vol. 40(1), pages 63-80, January.
    15. Lo, Andrew W. & Craig MacKinlay, A., 1990. "An econometric analysis of nonsynchronous trading," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 181-211.
    16. Robert A. Jarrow, 2009. "The Term Structure of Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 69-96, November.
    17. Robert A. Jarrow & Stuart M. Turnbull, 2008. "Pricing Derivatives on Financial Securities Subject to Credit Risk," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409, World Scientific Publishing Co. Pte. Ltd..
    18. 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.
    19. Cornell, Bradford & Green, Kevin, 1991. "The Investment Performance of Low-Grade Bond Funds," Journal of Finance, American Finance Association, vol. 46(1), pages 29-48, March.
    20. Pierre Collin-Dufresn & Robert S. Goldstein & J. Spencer Martin, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. repec:dau:papers:123456789/3369 is not listed on IDEAS
    2. Samir Kadiric & Arthur Korus, 2018. "Effects of Brexit on Corporate Yield Spreads: Evidence from UK and Eurozone Corporate Bond Markets," EIIW Discussion paper disbei251, Universitätsbibliothek Wuppertal, University Library.
    3. Bhanu Pratap Singh Thakur & M. Kannadhasan & Vinay Goyal, 2018. "Determinants of corporate credit spread: evidence from India," DECISION: Official Journal of the Indian Institute of Management Calcutta, Springer;Indian Institute of Management Calcutta, vol. 45(1), pages 59-73, March.
    4. Li, Xiao-Lin & Li, Xin & Si, Deng-Kui, 2020. "Asymmetric determinants of corporate bond credit spreads in China: Evidence from a nonlinear ARDL model," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    5. Dailami, Mansoor & Masson, Paul R. & Padou, Jean Jose, 2008. "Global monetary conditions versus country-specific factors in the determination of emerging market debt spreads," Journal of International Money and Finance, Elsevier, vol. 27(8), pages 1325-1336, December.
    6. Samir Kadiric & Arthur Korus, 2019. "The effects of Brexit on credit spreads: Evidence from UK and Eurozone corporate bond markets," International Economics and Economic Policy, Springer, vol. 16(1), pages 65-102, March.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Wahyudi, Imam & Robbi, Abdu, 2009. "Exploring Determinant Factors of Bond Trading with Inventory Management Theory (Case Study of Indonesian Capital Market, January – March 2009)," MPRA Paper 59883, University Library of Munich, Germany, revised 16 Jul 2010.
    2. Ephraim Clark & Selima Baccar, 2018. "Modelling credit spreads with time volatility, skewness, and kurtosis," Annals of Operations Research, Springer, vol. 262(2), pages 431-461, March.
    3. Gregory Connor & Lisa R. Goldberg & Robert A. Korajczyk, 2010. "Portfolio Risk Analysis," Economics Books, Princeton University Press, edition 1, number 9224.
    4. Stephanie Heck, 2022. "Corporate bond yields and returns: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 36(2), pages 179-201, June.
    5. Bhanot, Karan, 2005. "What causes mean reversion in corporate bond index spreads? The impact of survival," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1385-1403, June.
    6. Ramaprasad Bhar, 2010. "Stochastic Filtering with Applications in Finance," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 7736, January.
    7. Jun Yang, 2008. "Macroeconomic Determinants of the Term Structure of Corporate Spreads," Staff Working Papers 08-29, Bank of Canada.
    8. John Y. Campbell & Glen B. Taksler, 2003. "Equity Volatility and Corporate Bond Yields," Journal of Finance, American Finance Association, vol. 58(6), pages 2321-2350, December.
    9. Maciej Firla-Cuchra, 2005. "Explaining Launch Spreads on Structured Bonds," Economics Series Working Papers 230, University of Oxford, Department of Economics.
    10. Kim, Dong H. & Stock, Duane, 2014. "The effect of interest rate volatility and equity volatility on corporate bond yield spreads: A comparison of noncallables and callables," Journal of Corporate Finance, Elsevier, vol. 26(C), pages 20-35.
    11. Maclachlan, Iain C, 2007. "An empirical study of corporate bond pricing with unobserved capital structure dynamics," MPRA Paper 28416, University Library of Munich, Germany.
    12. Becchetti, Leonardo & Carpentieri, Andrea & Hasan, Iftekhar, 2009. "The determinants of option-adjusted delta credit spreads : a comparative analysis of the United States, the United Kingdom and the euro area," Research Discussion Papers 34/2009, Bank of Finland.
    13. Landschoot, Astrid Van, 2008. "Determinants of yield spread dynamics: Euro versus US dollar corporate bonds," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2597-2605, December.
    14. repec:wyi:journl:002109 is not listed on IDEAS
    15. Ericsson, Jan & Jacobs, Kris & Oviedo, Rodolfo, 2009. "The Determinants of Credit Default Swap Premia," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 109-132, February.
    16. Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 631-678, July.
    17. Becchetti, Leonardo & Carpentieri, Andrea & Hasan, Iftekhar, 2009. "The determinants of option-adjusted delta credit spreads: a comparative analysis of the United States, the United Kingdom and the euro area," Bank of Finland Research Discussion Papers 34/2009, Bank of Finland.
    18. Guo, Liang, 2013. "Determinants of credit spreads: The role of ambiguity and information uncertainty," The North American Journal of Economics and Finance, Elsevier, vol. 24(C), pages 279-297.
    19. Hamerle, Alfred & Liebig, Thilo & Rösch, Daniel, 2003. "Credit Risk Factor Modeling and the Basel II IRB Approach," Discussion Paper Series 2: Banking and Financial Studies 2003,02, Deutsche Bundesbank.
    20. Samir Kadiric & Arthur Korus, 2019. "The effects of Brexit on credit spreads: Evidence from UK and Eurozone corporate bond markets," International Economics and Economic Policy, Springer, vol. 16(1), pages 65-102, March.
    21. Carolina Castagnetti & Eduardo Rossi, 2013. "Euro Corporate Bond Risk Factors," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 28(3), pages 372-391, April.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:202. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Digital Media Team (email available below). General contact details of provider: https://edirc.repec.org/data/boegvuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.