A New Take on the Relationship between Interest rates and Credit Spreads

55 Pages Posted: 14 May 2019

See all articles by Brice V. Dupoyet

Brice V. Dupoyet

Florida International University - College of Business Administration - Finance

Xiaoquan Jiang

Florida International University (FIU) - Department of Finance

Qianying Zhang

affiliation not provided to SSRN

Date Written: October 18, 2016

Abstract

We revisit the link between interest rates and corporate bond credit spreads by applying Rigobon’s (2003) heteroskedasticity identification methodology to their interconnected dynamics through a bivariate VAR system. This novel approach allows us to account for endogeneity issues and to use this framework to test the various possible explanations for the credit spread – interest rate relation that have been proposed by the literature over the years. This innovative methodology allows us to conclude that credit spreads do indeed respond negatively to interest rates, yet that this negative relation is surprisingly robust to macroeconomic shocks, interest rates characteristics, different volatility regimes, and bond ratings. We also find the magnitude of the negative relation to be larger for high-yield bonds than for investment-grade bonds. Additionally, we are also able to rule out business cycles, the optionlike feature of callable bonds proposed by Duffee (1998), as well as the term spread as the main drivers of the negative nature of the relationship.

JEL Classification: G12, G18, E43

Suggested Citation

Dupoyet, Brice and Jiang, Xiaoquan and Zhang, Qianying, A New Take on the Relationship between Interest rates and Credit Spreads (October 18, 2016). Available at SSRN: https://ssrn.com/abstract=3355722 or http://dx.doi.org/10.2139/ssrn.3355722

Brice Dupoyet (Contact Author)

Florida International University - College of Business Administration - Finance ( email )

University Park, RB 209 A
11200 SW 8th Street
Miami, FL 33199
United States
305-348-3328 (Phone)
305-348-4245 (Fax)

Xiaoquan Jiang

Florida International University (FIU) - Department of Finance ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

Qianying Zhang

affiliation not provided to SSRN

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