Explaining the Rate Spread on Corporate Bonds

64 Pages Posted: 11 Nov 2008

See all articles by Edwin J. Elton

Edwin J. Elton

New York University (NYU) - Department of Finance

Martin J. Gruber

New York University (NYU) - Department of Finance

Deepak Agrawal

New York University (NYU)

Christopher Mann

Columbia University, School of Professional Studies

Date Written: September 1999

Abstract

The purpose of this article is to explain the spread between spot rates on corporate and government bonds. We find that the spread can be explained in terms of three elements: (1) compensation for expected default of corporate bonds (2) compensation for state taxes since holders of corporate bonds pay state taxes while holders of government bonds do not, and (3) compensation for the additional systematic risk in corporate bond returns relative to government bond returns. The systematic nature of corporate bond return is shown by relating that part of the spread which is not due to expected default or taxes to a set of variables which have been shown to effect risk premiums in stock markets Empirical estimates of the size of each of these three components are provided in the paper. We stress the tax effects because it has been ignored in all previous studies of corporate bonds.

Suggested Citation

Elton, Edwin J. and Gruber, Martin J. and Agrawal, Deepak and Mann, Christopher, Explaining the Rate Spread on Corporate Bonds (September 1999). NYU Working Paper No. FIN-99-082, Available at SSRN: https://ssrn.com/abstract=1299452

Edwin J. Elton (Contact Author)

New York University (NYU) - Department of Finance ( email )

44 West 4th Street
Ste 9-190
New York, NY 10012-1126
United States
212-998-0361 (Phone)
212-995-4233 (Fax)

Martin J. Gruber

New York University (NYU) - Department of Finance ( email )

44 West 4th Street
Ste 9-190
New York, NY 10012-1126
United States
212-998-0333 (Phone)
212-995-4233 (Fax)

Deepak Agrawal

New York University (NYU)

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

Christopher Mann

Columbia University, School of Professional Studies ( email )

3022 Broadway
New York, NY 10027
United States

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