Insolvency or liquidity squeeze? Explaining very short-term corporate yield spreads

Daniel M. Covitz and Chris Downing
Additional contact information
Daniel M. Covitz: https://www.federalreserve.gov/econres/daniel-m-covitz.htm

No 2002-45, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: In this paper, we first document some stylized facts about very short-term and long-term corporate yield spreads. We find that short-term spreads are sizable, and the correlations between many firms' short-term and long-term yield spreads are at times negative. We then develop a structural model that generates levels and correlations of short-term and long-term spreads that are more consistent with what we observe. The model allows for the possibility of payment delays when a firm's liquid asset position deteriorates. Payment delays generate sizable short-term debt spreads because the realized returns on short-term investments are very sensitive to an increase in the holding period. The presence of liquidity risk can also explain negative correlations between short- and long-term spreads because liquidity risk is imperfectly correlated with insolvency risk. Using firm-level data, we provide empirical evidence that liquid assets holdings help predict short-term spreads, but not long-term spreads.

Keywords: Corporations; Payment systems; Econometric models (search for similar items in EconPapers)
Date: 2002
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://www.federalreserve.gov/pubs/feds/2002/200245/200245abs.html (text/html)
http://www.federalreserve.gov/pubs/feds/2002/200245/200245pap.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2002-45

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ; Keisha Fournillier ().