The Global Credit Spread Puzzle

Posted: 24 Sep 2019 Last revised: 29 Oct 2020

See all articles by Jing-Zhi Huang

Jing-Zhi Huang

Pennsylvania State University - University Park - Department of Finance

Yoshio Nozawa

Hong Kong University of Science and Technology

Zhan Shi

Tsinghua University - PBC School of Finance

Date Written: September 15, 2019

Abstract

Using security-level credit spread data in eight developed economies, we document a large cross-country difference in credit spreads conditional on credit ratings and other default risk measures. The standard structural models not only fail to explain this cross-country variation in spreads but also have difficulty predicting credit spreads accurately. We implement an extended structural model that incorporates endogenous liquidity in the secondary market and find that this model largely explains credit spreads in the cross section and over time, as well as significantly reduces pricing errors. Therefore, default risk itself is an unlikely explanation for international corporate bond spreads.

Keywords: Corporate credit spreads, Credit spread puzzle, Structural credit risk models, Merton model, Black and Cox model, CDS, Fixed income asset pricing

JEL Classification: G12, G13

Suggested Citation

Huang, Jing-Zhi Jay and Nozawa, Yoshio and Shi, Zhan, The Global Credit Spread Puzzle (September 15, 2019). PBCSF-NIFR Research Paper, Available at SSRN: https://ssrn.com/abstract=3453959 or http://dx.doi.org/10.2139/ssrn.3453959

Jing-Zhi Jay Huang

Pennsylvania State University - University Park - Department of Finance ( email )

University Park, PA 16802
United States

HOME PAGE: http://www.personal.psu.edu/jxh56

Yoshio Nozawa (Contact Author)

Hong Kong University of Science and Technology ( email )

Clearwater Bay Road
Sai Kun, NT
Hong Kong

Zhan Shi

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing, 100083
China
86-10-62780862 (Phone)

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