Credit Spreads on Sterling Corporate Bonds and the Term Structure of UK Interest Rates

Bank of England Working Paper No. 202

22 Pages Posted: 14 Jan 2005

Date Written: October 2003

Abstract

This paper explores the relationship between credit spreads on sterling corporate bonds and the term structure of UK interest rates. In particular, it examines whether credit spreads are a reliable indicator of corporate bond default risk. Using daily price quotes from 1990 to 1998, the paper finds a small negative relationship between credit spreads on sterling investment-grade corporate bonds and the level and slope of the term structure of UK interest rates. The results are weaker than those found by Longstaff and Schwartz (1995) and Duffee (1996 and 1998) who both examine the relationship between US corporate bond credit spreads and the term structure of US interest rates. The weak relationship found suggests that credit spreads on sterling investment-grade corporate bonds have been driven by factors other than default risk. If so, we should be cautious in interpreting such credit spreads as measures of bond default risk. This result is important to both those in the field of financial stability interested in leading indicators of corporate defaults, and to monetary policy makers interested in the impact of interest rate changes on corporate bond default risk. Similar work should be repeated for sterling sub investment-grade corporate bonds once a sufficiently large data set can be assembled.

Suggested Citation

Leake, Jeremy, Credit Spreads on Sterling Corporate Bonds and the Term Structure of UK Interest Rates (October 2003). Bank of England Working Paper No. 202, Available at SSRN: https://ssrn.com/abstract=586805 or http://dx.doi.org/10.2139/ssrn.586805

Jeremy Leake (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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