Market Conditions, Default Risk and Credit Spreads

40 Pages Posted: 26 Feb 2008 Last revised: 3 Aug 2010

See all articles by Dragon Yongjun Tang

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics

Hong Yan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Multiple version iconThere are 2 versions of this paper

Date Written: May 19, 2009

Abstract

This study empirically examines the impact of the interaction between market and default risk on corporate credit spreads. Using credit default swap (CDS) spreads, we find that average credit spreads decrease in GDP growth rate, but increase in GDP growth volatility and jump risk in the equity market. At the market level, investor sentiment is the most important determinant of credit spreads. At the firm level, credit spreads generally rise with cash flow volatility and beta, with the effect of cash flow beta varying with market conditions. We identify implied volatility as the most significant determinant of default risk among firm-level characteristics. Overall, a major portion of individual credit spreads is accounted for by firm-level determinants of default risk, while macroeconomic variables are directly responsible for a lesser portion.

Keywords: Credit Risk, Credit Default Swaps, Credit Spreads, Market Conditions

JEL Classification: G12, G13, E43, E44

Suggested Citation

Tang, Dragon Yongjun and Yan, Hong, Market Conditions, Default Risk and Credit Spreads (May 19, 2009). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1098108

Dragon Yongjun Tang (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

KKL 1004
Pokfulam Road
Pokfulam
Hong Kong
(852)22194321 (Phone)

Hong Yan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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