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Decomposing credit spreads

Author

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  • Rohan Churm
  • Nikolaos Panigirtzoglou

Abstract

This paper investigates the information contained in the yields of corporate debt securities using a structural credit risk model. As previous studies have found, credit risk is not the only factor that affects corporate yield spreads. The aim is to decompose credit spreads, using a structural model of credit risk, into credit and non-credit risk components. The contribution relative to the existing literature is the use of contemporaneous forward-looking information on equity risk premia and equity value uncertainty in a structural model. In particular, implied equity risk premia from a three-stage dividend discount model that incorporates analysts' long-term earnings forecasts are used, together with implied measures of equity value uncertainty from option prices. The paper examines the evolution of the different components of spreads across time as well as the effect of particular events. It also analyses the relationship between the derived components and other financial variables, such as swap spreads and the equity risk premium.

Suggested Citation

  • Rohan Churm & Nikolaos Panigirtzoglou, 2005. "Decomposing credit spreads," Bank of England working papers 253, Bank of England.
    • Handle: RePEc:boe:boeewp:253
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    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2005/WP253.pdf
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    References listed on IDEAS

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    7. 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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    Cited by:

    1. Annaert, Jan & De Ceuster, Marc & Van Roy, Patrick & Vespro, Cristina, 2013. "What determines Euro area bank CDS spreads?," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 444-461.
    2. Shah, Syed Noaman & Kebewar, Mazen, 2013. "US Corporate Bond Yield Spread. A default risk debate," EconStor Preprints 73690, ZBW - Leibniz Information Centre for Economics.
    3. Shinsuke Ohyama & Takuya Sugimoto, 2007. "The determinants of credit spread changes in Japan," Bank of Japan Working Paper Series 07-E-4, Bank of Japan.
    4. Dötz, Niko, 2014. "Decomposition of country-specific corporate bond spreads," Discussion Papers 37/2014, Deutsche Bundesbank.
    5. Syed Muhammad Noaman Ahmed Shah & Mazen Kebewar, 2013. "US Corporate Bond Yield Spread: A default risk debate," Working Papers halshs-00798660, HAL.
    6. SHAH, Syed Muhammad Noaman Ahmed & KEBEWAR, mazen, 2013. "US Corporate Bond Yield Spread: A default risk debate," MPRA Paper 44887, University Library of Munich, Germany.
    7. Azad, A.S.M.S. & Azmat, Saad & Chazi, Abdelaziz & Ahsan, Amirul, 2018. "Can Islamic banks have their own benchmark?," Emerging Markets Review, Elsevier, vol. 35(C), pages 120-136.

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