Real Interest Rates and the Default Rate on High-Yield Bonds

Abstract

Determinants of the aggregate default rate on high-yield bonds have been of interest at least since 1990 - 1991, when the proportion of defaulting issued reached effectively its highest level since the Great Depression. With recovery by the mid-19902, and a new record volume of issuance in 1993, analysts have wondered whether another wave of financial failures will follow. This research shows that nominal interest rates are not highly correlated with aggregate default rates on high-yield bonds. Real rates, however, significantly enhance analysts' ability to explain default rates. The effect is lagged by two years' meaning that investors can estimate future credit experience fairly accurately without having unique insights into the direction of the economy or financial markets.

JEL Classification: G32, G33