The Credit Spread Puzzle - Model-Free Evidence from a Natural Experiment
22 Pages Posted: 4 Aug 2020
Date Written: June 30, 2020
Prior literature mostly finds bond yield spreads to be insufficiently explained by credit risk (the 'credit spread puzzle'). Recently, Feldhütter and Schaefer (2018) and Bai et al. (2020) revived this debate. We utilize the removal of sovereign guarantees for savings banks and state banks in Germany as a unique natural experiment allowing model-free identification of the credit risk component. During a transition period of over ten years, bonds of the same issuer with and without credit risk could be directly compared. Interestingly, less than 20% of the yield spread is due to credit risk for these bonds.
Keywords: Credit Spread Puzzle, Credit Risk, Sovereign Guarantees, Model-Free Identification
JEL Classification: G12, G28, G21
Suggested Citation: Suggested Citation