IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Market conditions, default risk and credit spreads

  • Tang, Dragon Yongjun
  • Yan, Hong
Registered author(s):

This study empirically examine the impact of market conditions on credit spreads as motivated by recently developed structural credit risk models. Using credit default swap (CDS) spreads, we find that, in the time series, average credit spreads are decreasing in GDP growth rate, but increasing in GDP growth volatility. We document that credit spreads are lower when investor sentiment is high and when the systematic jump risk is low. In the cross section, we confirm that firm-level cash flow volatility raises credit spreads. More importantly, we demonstrate that the impact of market conditions on credit spreads is substantially affected by firm heterogeneity. During economic expansions, ceteris paribus, firms with high cash flow betas have lower credit spreads than those with low cash flow betas. This relation disappears during economic recessions, consistent with theoretical predictions.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: https://econstor.eu/bitstream/10419/19785/1/200808dkp_b_.pdf
Download Restriction: no

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2008,08.

as
in new window

Length:
Date of creation: 2008
Date of revision:
Handle: RePEc:zbw:bubdp2:7318
Contact details of provider: Postal:
Postfach 10 06 02, 60006 Frankfurt

Phone: 0 69 / 95 66 - 34 55
Fax: 0 69 / 95 66 30 77
Web page: http://www.bundesbank.de/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Duffie, Darrell & Saita, Leandro & Wang, Ke, 2007. "Multi-period corporate default prediction with stochastic covariates," Journal of Financial Economics, Elsevier, vol. 83(3), pages 635-665, March.
  2. Edwin J. Elton, 2001. "Explaining the Rate Spread on Corporate Bonds," Journal of Finance, American Finance Association, vol. 56(1), pages 247-277, 02.
  3. Jan Ericsson & Kris Jacobs & Rodolfo A. Oviedo, 2004. "The Determinants of Credit Default Swap Premia," CIRANO Working Papers 2004s-55, CIRANO.
  4. Roberto Blanco & Simon Brennan & Ian W Marsh, 2004. "An empirical analysis of the dynamic relationship between investment-grade bonds and credit default swaps," Bank of England working papers 211, Bank of England.
  5. Dan Covitz & Chris Downing, 2007. "Liquidity or Credit Risk? The Determinants of Very Short-Term Corporate Yield Spreads," Journal of Finance, American Finance Association, vol. 62(5), pages 2303-2328, October.
  6. John Y. Campbell & Tuomo Vuolteenaho, 2003. "Bad Beta, Good Beta," Harvard Institute of Economic Research Working Papers 2016, Harvard - Institute of Economic Research.
  7. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
  8. Mitchell A. Petersen, 2005. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," NBER Working Papers 11280, National Bureau of Economic Research, Inc.
  9. Long Chen & David A. Lesmond & Jason Wei, 2007. "Corporate Yield Spreads and Bond Liquidity," Journal of Finance, American Finance Association, vol. 62(1), pages 119-149, 02.
  10. Margaret M. McConnell & Gabriel Perez Quiros, 1997. "Output fluctuations in the United States: what has changed since the early 1980s?," Research Paper 9735, Federal Reserve Bank of New York.
  11. 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.
  12. Alexander David, 2008. "Inflation Uncertainty, Asset Valuations, and the Credit Spreads Puzzle," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2487-2534, November.
  13. James H. Stock & Mark W. Watson, 2003. "Has the Business Cycle Changed and Why?," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 159-230 National Bureau of Economic Research, Inc.
  14. Hackbarth, Dirk & Miao, Jianjun & Morellec, Erwan, 2006. "Capital structure, credit risk, and macroeconomic conditions," Journal of Financial Economics, Elsevier, vol. 82(3), pages 519-550, December.
  15. Campbell, John & Taksler, Glen, 2003. "Equity Volatility and Corporate Bond Yields," Scholarly Articles 3153307, Harvard University Department of Economics.
  16. David M Kreps & Evan L Porteus, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Levine's Working Paper Archive 625018000000000009, David K. Levine.
  17. Samuel Hanson & M. Hashem Pesaran & Til Schuermann, 2005. "Firm Heterogeneity and Credit Risk Diversification," CESifo Working Paper Series 1531, CESifo Group Munich.
  18. Minton, Bernadette A. & Schrand, Catherine, 1999. "The impact of cash flow volatility on discretionary investment and the costs of debt and equity financing," Journal of Financial Economics, Elsevier, vol. 54(3), pages 423-460, December.
  19. Bonfim, Diana, 2009. "Credit risk drivers: Evaluating the contribution of firm level information and of macroeconomic dynamics," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 281-299, February.
  20. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
  21. Carling, Kenneth & Jacobson, Tor & Linde, Jesper & Roszbach, Kasper, 2007. "Corporate credit risk modeling and the macroeconomy," Journal of Banking & Finance, Elsevier, vol. 31(3), pages 845-868, March.
  22. 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.
  23. Max Bruche & Carlos Gonzalez-Aguado, 2006. "Recovery rates, default probabilities and the credit cycle," LSE Research Online Documents on Economics 24524, London School of Economics and Political Science, LSE Library.
  24. Sanjiv R. Das & Darrell Duffie & Nikunj Kapadia & Leandro Saita, 2007. "Common Failings: How Corporate Defaults Are Correlated," Journal of Finance, American Finance Association, vol. 62(1), pages 93-117, 02.
  25. Malcolm Baker & Jeffrey Wurgler, 2004. "Investor Sentiment and the Cross-Section of Stock Returns," NBER Working Papers 10449, National Bureau of Economic Research, Inc.
  26. Martijn Cremers & Joost Driessen & Pascal Maenhout & David Weinbaum, 2005. "Explaining the level of credit spreads: option-implied jump risk premia in a firm value model," BIS Working Papers 191, Bank for International Settlements.
  27. Pesaran, M.H. & Schuermann, T. & Treutler, B-J. & Weiner, S.M., 2003. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," Cambridge Working Papers in Economics 0330, Faculty of Economics, University of Cambridge.
  28. Houweling, P. & Vorst, A.C.F., 2003. "Pricing default swaps: empirical evidence," Econometric Institute Research Papers EI 2003-51, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  29. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  30. Jarrow, Robert A. & Turnbull, Stuart M., 2000. "The intersection of market and credit risk," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 271-299, January.
  31. James H. Stock & Mark W. Watson, 2003. "Understanding Changes in International Business Cycle Dynamics," NBER Working Papers 9859, National Bureau of Economic Research, Inc.
  32. Duffie, Darrell & Epstein, Larry G, 1992. "Stochastic Differential Utility," Econometrica, Econometric Society, vol. 60(2), pages 353-94, March.
  33. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
  34. Hui Chen, 2010. "Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure," NBER Working Papers 16151, National Bureau of Economic Research, Inc.
  35. Lily Qiu & Ivo Welch, 2004. "Investor Sentiment Measures," NBER Working Papers 10794, National Bureau of Economic Research, Inc.
  36. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  37. Robert R. Bliss & Nikolaos Panigirtzoglou, 2004. "Option-Implied Risk Aversion Estimates," Journal of Finance, American Finance Association, vol. 59(1), pages 407-446, 02.
  38. Das, Sanjiv R. & Hanouna, Paul & Sarin, Atulya, 2009. "Accounting-based versus market-based cross-sectional models of CDS spreads," Journal of Banking & Finance, Elsevier, vol. 33(4), pages 719-730, April.
  39. Korajczyk, Robert A. & Levy, Amnon, 2003. "Capital structure choice: macroeconomic conditions and financial constraints," Journal of Financial Economics, Elsevier, vol. 68(1), pages 75-109, April.
  40. Uhrig-Homburg, Marliese, 2005. "Cash-flow shortage as an endogenous bankruptcy reason," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1509-1534, June.
  41. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  42. Dragon Tang & Hong Yan, 2006. "Macroeconomic Conditions, Firm Characteristics, and Credit Spreads," Journal of Financial Services Research, Springer;Western Finance Association, vol. 29(3), pages 177-210, June.
  43. Carlos A. Molina, 2005. "Are Firms Underleveraged? An Examination of the Effect of Leverage on Default Probabilities," Journal of Finance, American Finance Association, vol. 60(3), pages 1427-1459, 06.
  44. Jackwerth, Jens Carsten, 2000. "Recovering Risk Aversion from Option Prices and Realized Returns," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 433-51.
  45. Sheridan Titman & Stathis Tompaidis & Sergey Tsyplakov, 2005. "Determinants of Credit Spreads in Commercial Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 33(4), pages 711-738, December.
  46. Acharya, Viral V. & Bharath, Sreedhar T. & Srinivasan, Anand, 2007. "Does industry-wide distress affect defaulted firms? Evidence from creditor recoveries," Journal of Financial Economics, Elsevier, vol. 85(3), pages 787-821, September.
  47. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
  48. Long Chen & Pierre Collin-Dufresne & Robert S. Goldstein, 2009. "On the Relation Between the Credit Spread Puzzle and the Equity Premium Puzzle," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3367-3409, September.
  49. Dechow, Patricia M., 1994. "Accounting earnings and cash flows as measures of firm performance : The role of accounting accruals," Journal of Accounting and Economics, Elsevier, vol. 18(1), pages 3-42, July.
  50. Gurdip Bakshi & Dilip Madan & Frank Xiaoling Zhang, 2006. "Investigating the Role of Systematic and Firm-Specific Factors in Default Risk: Lessons from Empirically Evaluating Credit Risk Models," The Journal of Business, University of Chicago Press, vol. 79(4), pages 1955-1988, July.
  51. Harjoat S. Bhamra & Lars-Alexander Kuehn & Ilya A. Strebulaev, 2010. "The Levered Equity Risk Premium and Credit Spreads: A Unified Framework," Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 645-703, February.
  52. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-64, May.
  53. Pierre Collin-Dufresne, 2001. "Do Credit Spreads Reflect Stationary Leverage Ratios?," Journal of Finance, American Finance Association, vol. 56(5), pages 1929-1957, October.
  54. In Joon Kim & Krishna Ramaswamy & Suresh Sundaresan, 1993. "Does Default Risk in Coupons Affect the Valuation of Corporate Bonds?: A Contingent Claims Model," Financial Management, Financial Management Association, vol. 22(3), Fall.
  55. Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 499-544.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:zbw:bubdp2:7318. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics)

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.