Lehrstuhl für Finanzierung und Investition

Arbeitspapiere

"Are Credit Spreads and Interest Rates Co-Integrated? Empirical Analysis in the USD Corporate Bond Market"

Structural models for pricing risky debt imply a negative relationship between interest rates and credit spreads. In contrast, credit default swap pricing models assume independence between credit risk and the term structure of interest rates. So far, empirical studies have focused on first differences of time series and confirmed the negative relation implied by structural models based on Merton (1974). Nevertheless, the co-integration analysis of Morris, Neal and Rolph (1998) finds a positive long-run relation between the credit spread and the risk free interest rate which is not supported by the theoretical literature.

This paper analyses the relationship between different forms of credit spreads and interest rates using the co-integration approach developed by Engle and Granger (1987). Our study is based on weekly USD corporate bond index data which is con-trolled for rating ranging from 1994 to 2006. We confirm the negative relation be-tween credit spreads and interest rates with high statistical significance. Furthermore, we find that the S&P 500 stock index and the spread between the swap curve and the Treasury yield curve can be considered as additional factors explaining the credit spread.

Contents

1 Introduction

2 Credit Spread Methodology

2.1 Calculation of the Spreads
2.2 Different Forms of the Credit Spread
2.3 Information Captured in the Swap Spread

3 Review of the Literature

3.1 Evidence in Theoretical Models
3.2 Empirical Studies

4 Empirical Analysis

4.1 Motivation
4.2 Data and Methodology
4.3 Empirical Results: Swap Spread, Credit Spread, Spread over Swap
4.4 Discussion

5 Summary and Conclusions

Pape, Ulrich/Schlecker, Matthias: Are Credit Spreads and Interest Rates Co-integrated? Empirical Analysis in the USD Corporate Bond Market, Working Paper Nr. 25, ESCP-EAP Europäische Wirtschaftshochschule Berlin, May 2007.

Download (SSRN): Are Credit Spreads and Interest Rates Co-integrated?

Zum Vortrag angenommen:

• 14. Jahrestagung Deutsche Gesellschaft für Finanzwirtschaft, DGF, Dresden, 28.-29.09.2007.
• OR 2007: Operations Research Conference, Gesellschaft für Operations Research, Saarbrücken, 05.-07.09.2007.
• Campus for Finance Research Conference, WHU, Vallendar/Koblenz, 10.-11.01.2007.
• 30. Jahrestagung der Deutschen Gesellschaft für Klassifikation, Berlin, 08.-10.03.2006.