Determinants of Short-Term Corporate Yield Spreads: Evidence from the Commercial Paper Market

Abstract

What drives short-term credit spreads: credit risk, liquidity risk, or both? Despite a large empirical literature on corporate yield spreads, very few studies have examined this important question. Using a novel data set of secondary market transaction prices of Chinese commercial papers, we investigate the determinants of short-term credit spreads within the structural framework of credit risk modeling. In particular, we propose and test a structural model with rollover risk, jump risk, and market illiquidity that allows us to decompose commercial paper yield spreads into a credit component and a liquidity component in a unified manner. We find that both credit and liquidity factors are important determinants of short-term spreads and that, on average, the proposed structural model can largely match levels of commercial paper spreads. Furthermore, our decomposition results indicate that jump risk and market liquidity make equally important contributions to commercial paper spreads.

Keywords: Corporate credit spreads, Structural credit risk models, Commercial papers, Debt market liquidity

JEL Classification: G12, G13