Explaining Credit Spread Changes: Some New Evidence from Option-Adjusted Spreads of Bond Indices

Stern School of Business Working Paper No. FIN-03-013

Posted: 11 Jun 2003

See all articles by Jing-Zhi Huang

Jing-Zhi Huang

Pennsylvania State University - University Park - Department of Finance

Weipeng Kong

Pennsylvania State University

Multiple version iconThere are 5 versions of this paper

Date Written: March 2003

Abstract

This paper revisits the question of the determinants of corporate bond credit spreads using some new explanatory variables with both weekly and monthly option-adjusted credit spreads of corporate bond indices from Merrill Lynch. We find that among the new variables, the interest rate historical volatility, the Russell 2000 index historical return volatility and Conference Board leading and coincident economic indices have significant power in explaining credit spread changes, especially for high yield bond indices. Furthermore, these four variables plus the interest rate level, the yield curve slope, the Russell 2000 index return, and the Fama-French [1996] high-minus-low factor return could explain more than 40% of credit spread changes in 5 out of 9 rating/maturity indices. In particular, these variables could explain 67.68% of the variation in B rated index credit spreads and 60.82% of the variation in BB rated index credit spreads. The overall explanatory power on credit spread changes achieved here is a notable improvement over most previous studies using either option-adjusted index spreads or individual corporate bond spreads. Our analysis confirms that high-yield credit spread changes are more closely related with equity market factors and also provides evidence in favor of incorporating macroeconomic risk factors into credit risk models.

Suggested Citation

Huang, Jing-Zhi Jay and Kong, Weipeng, Explaining Credit Spread Changes: Some New Evidence from Option-Adjusted Spreads of Bond Indices (March 2003). Stern School of Business Working Paper No. FIN-03-013, Available at SSRN: https://ssrn.com/abstract=396620 or http://dx.doi.org/10.2139/ssrn.396620

Jing-Zhi Jay Huang (Contact Author)

Pennsylvania State University - University Park - Department of Finance ( email )

University Park, PA 16802
United States

HOME PAGE: http://www.personal.psu.edu/jxh56

Weipeng Kong

Pennsylvania State University

University Park
State College, PA 16802
United States

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