Market Conditions, Default Risk and Credit Spreads
40 Pages Posted: 26 Feb 2008 Last revised: 3 Aug 2010
Date Written: May 19, 2009
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: Suggested Citation