Decomposing Corporate Bond Spreads

Abstract

Sterling, dollar and euro-denominated corporate bond spreads narrowed substantially between late 2002 and mid-2007, but widened abruptly during the recent financial market turmoil. This article uses a structural credit risk model to examine the extent to which movements in spreads over the past decade have been driven by credit and non-credit related factors. Compensation for bearing non-credit related illiquidity risk appears to have been a particularly important driver of high-yield spreads, including during the recent financial market turmoil, but the compensation required for credit risk has also increased recently.