The Myth of the Credit Spread Puzzle

Abstract

Are standard structural models able to explain credit spreads on corporate bonds? In contrast to much of the literature, we find that the Black-Cox model matches the level of investmentgrade spreads well. Model spreads for speculative-grade debt are too low, and we find that bond illiquidity contributes to this underpricing. Our analysis makes use of a new approach for calibrating the model to historical default rates that leads to more precise estimates of investment-grade default probabilities. (JEL C23, G12, G13)

Time‐Varying Asset Volatility and the Credit Spread Puzzle

“…20 These ratios are comparable to what has been reported in Berndt et al (2018), and Doshi et al (2013). 21 The asset volatility value is based on Feldhütter and Schaefer (2018) and the leverage value from Huang and Huang (2012).…”

“…14 Historical leverage ratios, payout rates, and recovery rates are also used as inputs. 15 Asset volatility of 29% is based on the median estimate in Feldhütter and Schaefer (2018) for that rating category. We use the Sharpe ratio reported in CCG for the period 1974 to 1998.…”

“…Asset volatility of 29% is based on the median estimate in Feldhütter and Schaefer () for that rating category. We use the Sharpe ratio reported in CCG for the period 1974 to 1998.…”

“…The asset volatility value is based on Feldhütter and Schaefer () and the leverage value from Huang and Huang ().…”

Does Borrowing from Banks Cost More than Borrowing from the Market?

“…These data are available from 1997 to 2017 and form the basis of Bank of America's bond indices. In academic research, they are used by Schaefer and Strebulaev () and Feldhutter and Schaefer (). Quote data provide better coverage than transaction data, which are available from TRACE on the origination date for 357 out of 1,682 loans in the full bond‐loan sample.…”