Credit Spread Changes within Switching Regimes

48 Pages Posted: 12 Feb 2009 Last revised: 11 Mar 2013

See all articles by Olfa Maalaoui Chun

Olfa Maalaoui Chun

Korea Advanced Institute of Science and Technology (KAIST) - Graduate School of Finance

Georges Dionne

HEC Montreal - Department of Finance

Pascal Francois

HEC Montreal - Department of Finance

Date Written: October 1, 2010

Abstract

Empirical studies on credit spread determinants are predicated on the presence of a single-regime over the entire sample period and thus find limited explanatory power. We show that a single regime model hides the fact that the explanatory variables take on different loadings across changing patterns in credit spreads. We capture these hidden effects by modeling endogenous (rating-specific) regimes for credit spreads. We find that in a two regime-based model traditional determinants have significant explanatory power consistent with the prediction of structural models, yet their importance changes across regimes -- some variables have their effects strengthen, weaken or even reverse signs across regimes. We also investigate the differing behavior of these loadings across different specifications of the economic cycle and find that endogenous regimes best capture the hidden effects of these variables with the highest explanatory power for the same set of variables.

Keywords: Credit spread, Markov switching regimes, market risk, liquidity risk, default risk, credit cycle, NBER economic cycle.

JEL Classification: C32, C52, C61, G12, G13

Suggested Citation

Maalaoui Chun, Olfa and Dionne, Georges and Francois, Pascal, Credit Spread Changes within Switching Regimes (October 1, 2010). Paris December 2009 Finance International Meeting AFFI - EUROFIDAI, Available at SSRN: https://ssrn.com/abstract=1341870 or http://dx.doi.org/10.2139/ssrn.1341870

Olfa Maalaoui Chun (Contact Author)

Korea Advanced Institute of Science and Technology (KAIST) - Graduate School of Finance ( email )

207-43 Cheongryangri-2dong 130-722
Seoul
Korea

Georges Dionne

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Pascal Francois

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

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