Cash Flow Volatility and Corporate Bond Yield Spreads

39 Pages Posted: 23 Sep 2012 Last revised: 21 Jan 2013

See all articles by Alan V. S. Douglas

Alan V. S. Douglas

University of Waterloo - School of Accounting and Finance

Alan Guoming Huang

University of Waterloo

Kenneth R. Vetzal

University of Waterloo

Date Written: September 22, 2012

Abstract

We conduct a detailed empirical study of the effects of cash flow volatility on corporate bond yield spreads. Using a lengthy sample of transaction prices for investment grade straight bonds, we show that cash flow risk has strong statistical significance and economic effects on spreads, after controlling for a large number of factors which are known to be important determinants of spreads such as equity return volatility, credit rating, time to maturity, coupon rate, interest coverage ratio, leverage ratio, etc. The effects of cash flow risk are magnified considerably for firms that are at greater risk of default, as proxied by either relatively low interest coverage ratios or relatively low credit ratings. We consider several alternative ways to measure cash flow risk. While all of them exhibit strong statistical and economic significance, the squared difference between the current quarter's cash flow relative to that from the same quarter in the preceding year stands out as being particularly important.

Keywords: Corporate bond yield spreads, cash flow volatility, equity return volatility, credit ratings, regime-switching

JEL Classification: G11, G12

Suggested Citation

Douglas, Alan V. S. and Huang, Alan G. and Vetzal, Kenneth R., Cash Flow Volatility and Corporate Bond Yield Spreads (September 22, 2012). Midwest Finance Association 2013 Annual Meeting Paper. Available at SSRN: https://ssrn.com/abstract=2150685 or http://dx.doi.org/10.2139/ssrn.2150685

Alan V. S. Douglas

University of Waterloo - School of Accounting and Finance ( email )

289 Hagey Hall
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 Ext. 5945 (Phone)

HOME PAGE: http://www.arts.uwaterloo.ca/ACCT/people/douglas.htm

Alan G. Huang (Contact Author)

University of Waterloo ( email )

School of Accounting and Finance
Waterloo, Ontario N2L 3G1
Canada
519-888 4567 ext. 36770 (Phone)

Kenneth R. Vetzal

University of Waterloo ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1 N2L 3G1
Canada
519-885-1211 (Phone)
519-888-7562 (Fax)

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