Market conditions, default risk and credit spreads

Dragon Yongjun Tang and Hong Yan ()

No 2008,08, Discussion Paper Series 2: Banking and Financial Studies from Deutsche Bundesbank, Research Centre

Abstract: This study empirically examine the impact of market conditions on credit spreads as motivated by recently developed structural credit risk models. Using credit default swap (CDS) spreads, we find that, in the time series, average credit spreads are decreasing in GDP growth rate, but increasing in GDP growth volatility. We document that credit spreads are lower when investor sentiment is high and when the systematic jump risk is low. In the cross section, we confirm that firm-level cash flow volatility raises credit spreads. More importantly, we demonstrate that the impact of market conditions on credit spreads is substantially affected by firm heterogeneity. During economic expansions, ceteris paribus, firms with high cash flow betas have lower credit spreads than those with low cash flow betas. This relation disappears during economic recessions, consistent with theoretical predictions.

Keywords: Credit Risk; Credit Default Swaps; Credit Spreads; Market Conditions (search for similar items in EconPapers)
JEL-codes: G13 G12 E44 E43 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk, nep-mac and nep-rmg
Date: 2008
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Persistent link: http://EconPapers.repec.org/RePEc:zbw:bubdp2:7318

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