Macroeconomic Conditions, Firm Characteristics, and Credit Spreads

49 Pages Posted: 23 Mar 2005

See all articles by Dragon Yongjun Tang

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics

Hong Yan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Date Written: March 15, 2005

Abstract

We study a structural model that allows us to examine how credit spreads are affected by the interaction of macroeconomic conditions and firm characteristics. Unlike most other structural models, our model explicitly incorporates equilibrium macroeconomic dynamics and models a firm's cash flow as primitive processes. Corporate securities are priced as contingent claims written on cash flows. Default occurs when the firm's cash flow cannot cover the interest payments and the recovery rate is dependent on the economic condition at default. Our model produces the following predictions: (i) credit spread is negatively correlated with interest rate and, ceteris paribus, this correlation is stronger for bonds with higher default probabilities; (ii) credit spread yield curves are upward sloping for low-grade bonds; (iii) firm characteristics other than leverage ratios have significant effects on credit spreads and these effects also vary with economic conditions. These predictions are consistent with the available empirical evidence and generate implications for further empirical investigation.

Keywords: Default Risk, Macroeconomic Conditions, Credit Spread

JEL Classification: G12, G13, E43, E44

Suggested Citation

Tang, Dragon Yongjun and Yan, Hong, Macroeconomic Conditions, Firm Characteristics, and Credit Spreads (March 15, 2005). Available at SSRN: https://ssrn.com/abstract=687281 or http://dx.doi.org/10.2139/ssrn.687281

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics ( email )

KKL 1004
Pokfulam Road
Pokfulam
Hong Kong
(852)22194321 (Phone)

Hong Yan (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
493
Abstract Views
3,428
rank
68,422
PlumX Metrics