The Nonlinear Dynamics of Corporate Bond Spreads: Regime-Dependent Effects of their Determinants
Forthcoming in: Journal of Economics and Statistics
59 Pages Posted: 24 Jan 2021
Date Written: December 3, 2020
This paper studies the behavior of corporate bond spreads during different market regimes between 2004 and 2016. Applying a Markov-switching vector autoregressive (MS-VAR) model, we document that the dynamic impact of spread determinants varies substantially with market conditions. In periods of high volatility, systematic credit risk—rather than interest rate movements— contributes to driving up spreads. Moreover, while market-wide liquidity risk is not priced when volatility is low, it becomes a crucial factor during stress periods. Our results challenge the notion that spreads predominantly capture credit risk and suggest it must be reassessed during periods of financial distress.
Keywords: Corporate bond spreads, regime dependency, Markov switching, vector autoregression, credit spread puzzle
JEL Classification: C32, C34, C58, G12
Suggested Citation: Suggested Citation