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US Corporate Bond Yield Spread. A default risk debate

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Listed author(s):
  • Shah, Syed Noaman
  • Kebewar, Mazen
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    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.

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    File URL: https://www.econstor.eu/bitstream/10419/73690/1/US%20Corporate%20Bond%20Yield%20Spread%20A%20default%20risk%20debate.pdf
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    Paper provided by ZBW - German National Library of Economics in its series EconStor Preprints with number 73690.

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    Date of creation: 08 Mar 2013
    Handle: RePEc:zbw:esprep:73690
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    Keywords: Default risk; Credit spread; Risk-aversion; Measurement error; Index construction;

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    Find related papers by 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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    1. Lawrence Fisher, 1959. "Determinants of Risk Premiums on Corporate Bonds," Journal of Political Economy, University of Chicago Press, vol. 67, pages 217-217.
    2. 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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    5. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    6. 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.
    7. 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, 09.
    8. 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.
    9. Jan Ericsson & Olivier Renault, 2006. "Liquidity and Credit Risk," Journal of Finance, American Finance Association, vol. 61(5), pages 2219-2250, October.
    10. 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.
    11. Rohan Churm & Nikolaos Panigirtzoglou, 2005. "Decomposing credit spreads," Bank of England working papers 253, Bank of England.
    12. Dick-Nielsen, Jens & Feldhütter, Peter & Lando, David, 2012. "Corporate bond liquidity before and after the onset of the subprime crisis," Journal of Financial Economics, Elsevier, vol. 103(3), pages 471-492.
    13. 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.
    14. Liu, Sheen & Shi, Jian & Wang, Junbo & Wu, Chunchi, 2009. "The determinants of corporate bond yields," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(1), pages 85-109, February.
    15. 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.
    16. Chance, Don M, 1990. " Default Risk and the Duration of Zero Coupon Bonds," Journal of Finance, American Finance Association, vol. 45(1), pages 265-274, March.
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