The Myth of the Credit Spread Puzzle

61 Pages Posted: 5 Dec 2013 Last revised: 16 Jan 2018

See all articles by Peter Feldhütter

Peter Feldhütter

Copenhagen Business School

Stephen M. Schaefer

London Business School - Institute of Finance and Accounting

Date Written: January 14, 2018

Abstract

We ask whether a standard structural model (Black and Cox (1976)) is able to explain credit spreads on corporate bonds and, in contrast to much of the literature, we find that the model matches the level of investment grade spreads well. Model spreads for speculative grade debt are too low and we find that bond illiquidity contributes to this underpricing. Our analysis makes use of a new approach for calibrating the model to historical default rates that leads to much more precise estimates of investment grade default probabilities.

Keywords: Credit spread puzzle, Merton model, Structural models, Corporate bond spreads, Realized default frequencies

JEL Classification: C23, G01, G12

Suggested Citation

Feldhütter, Peter and Schaefer, Stephen M., The Myth of the Credit Spread Puzzle (January 14, 2018). Available at SSRN: https://ssrn.com/abstract=2363081 or http://dx.doi.org/10.2139/ssrn.2363081

Peter Feldhütter (Contact Author)

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Stephen M. Schaefer

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 171 706 6887 (Phone)
+44 171 724 3317 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
414
Abstract Views
2,020
rank
69,799
PlumX Metrics