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The nonlinear dynamics of corporate bond spreads: Regime-dependent effects of their determinants

Henning Fischer and Oscar Stolper

No 08/2019, Discussion Papers from Deutsche Bundesbank

Abstract: This paper studies the behavior of corporate bond spreads during different market regimes between 2004 and 2016. Applying a Markov-switching vector autoregressive (MS-VAR) model, we document that the dynamic impact of spread determinants varies substantially with market conditions. In periods of high volatility, systematic credit risk - rather than interest rate movements - contributes to driving up spreads. Moreover, while market-wide liquidity risk is not priced when volatility is low, it becomes a crucial factor during stress periods. Our results challenge the notion that spreads predominantly capture credit risk and suggest it must be reassessed during periods of financial distress.

Keywords: corporate bond spreads; regime dependency; Markov switching; vector autoregression; credit spread puzzle (search for similar items in EconPapers)
JEL-codes: C32 C34 C58 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ets
Date: 2019
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