Commonality in Credit Spread Changes: Dealer Inventory and Intermediary Distress

82 Pages Posted: 26 Nov 2019

See all articles by Zhiguo He

Zhiguo He

University of Chicago - Finance

Paymon Khorrami

Imperial College Business School

Zhaogang Song

Johns Hopkins University - Carey Business School

Multiple version iconThere are 2 versions of this paper

Date Written: November 2019

Abstract

Two intermediary-based factors - a broad financial distress measure and a dealer corporate bond inventory measure - explain about 50% of the puzzling common variation of credit spread changes beyond canonical structural factors. A simple model, in which intermediaries facing margin constraints absorb supply of assets from customers, accounts for the documented explanatory power and delivers further implications with empirical support.

First, whereas bond sorts on margin-related variables (credit rating and leverage) produce monotonic patterns in loadings on intermediary factors, non-margin-related sorts produce no pattern. Second, dealer inventory co-moves with corporate-credit assets only, whereas intermediary distress co-moves even with non-corporate-credit assets. Third, dealers' inventory increases, and bond prices decline, in response to instrumented bond sales by institutional investors, using severe downgrades ("fallen angels'') and disaster-related insurance losses as IVs.

JEL Classification: G12, G22, G23

Suggested Citation

He, Zhiguo and Khorrami, Paymon and Song, Zhaogang, Commonality in Credit Spread Changes: Dealer Inventory and Intermediary Distress (November 2019). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2019-136, Available at SSRN: https://ssrn.com/abstract=3493297 or http://dx.doi.org/10.2139/ssrn.3493297

Zhiguo He (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://www.zhiguohe.com

Paymon Khorrami

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.paymonkhorrami.com

Zhaogang Song

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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