Ebook Determinants of Euro Term Structure of Credit Spreads
While many studies concentrate on theoretical models for the pricing of corporate bonds and credit risk, there has been much less empirical testing of these models. Yet, there are several reasons for investigating the determinants and behavior of credit spreads. First, the Euro corporate bond market, which lags its US counterpart, has become broader and more liquid. The number and the market value of Euro corporate bonds have more than doubled over the last decade.
The development of the A and BBB rated market segment has been particularly impressive, coming from virtual non-existence in early 1998, to account for almost half the individual rated bond issues outstanding in late 2003. Second, the credit derivatives market, including structured finance products such as collateralized debt obligations (CDO) and asset backed securities (ABS), has experienced considerable growth over the last two decades and is expected to grow strongly in the coming years. Some structured products such as collateralized bond obligations (CBO) are backed by a large pool of corporate bonds.
This implies that the cash flows (coupon and principal) of the underlying bonds determine the profitability of these structured products. Therefore, the creditworthiness of corporate bonds is important for the analysis of these products. Third, according to the Basel II Accord, credit risk models can be used as a basis for calculating a bank’s regulatory capital. To develop and use these models, one needs to make assumptions about what variables to include and the relation between credit risk and financial and macroeconomic variables such as, for example, the risk-free rate.
Finally, central bankers use credit spreads to assess (extract) default probabilities of firms and to assess the general functioning of financial markets (credit rationing and sectoral versus macroeconomic effects). In addition, the credit spread is often used as a business cycle indicator. Having a better understanding of credit spreads will help central bankers to extract more precise information from bond prices/spreads.
CONTENTS
1. Introduction
2. Determinants of Credit Spreads
- 2.1 Risk-free Interest Rate
2.2 Slope of the Term Structure
2.3 Asset Value
2.4 Asset Volatility
2.5 Measure of Liquidity
3. Modeling the Term Structure of Credit Spreads
- 3.1 Extended Nelson-Siegel Approach
3.2 Goodness of Fit Statistics
4. Empirical Analysis
- 4.1 Data Description
4.2 Estimating the Term Structure of Credit Spreads
- 4.2.1 Measures of Fit
4.2.2 Term Structure of Credit Spreads: Extended NS Model
4.3 Determinants of Credit Spread Changes
- 4.3.1 Model Specification and Data
4.3.2 Estimation Results
4.3.3 Robustness
5. Conclusion
References
Tables
Figures
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