Forecasting the Quality Spread Using Business Cycle Indicators
12 Pages Posted: 16 Apr 2001
Date Written: undated
Abstract
The spread between yields on corporate bonds of differing quality is one of the most important measures of the aggregate level of credit risk in the economy and has been widely used as an indicator of overall economic activity and of stock prices. It has also assumed considerable importance in recent years as a fundamental determinant of the profitability of complex investment strategies that depend upon the convergence of yields on securities with different credit risk. A good forecast of the quality spread is likely to be very useful both for economic forecasting and for investment management. In this paper we find a way to forecast the quality spread by utilizing the idea that the magnitude of the quality spread varies with fluctuations in overall economic activity and hence business cycle indicators are likely to contain information about the future evolution of the spread.
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