A Pure Test for the Elasticity of Yield Spreads

53 Pages Posted: 19 Jan 2007

See all articles by Gady Jacoby

Gady Jacoby

University of Manitoba - Department of Accounting and Finance; Seton Hall University

Jonathan A. Batten

RMIT University; The University of Sydney

Rose C. Liao

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics

Date Written: December 2006

Abstract

The correlation between interest rates and corporate bond yield spreads is a well-known feature of structural bond pricing models. Duffee (1998) argues that this correlation is weak once the effects of call options are removed from the data; a conclusion that contradicts the negative correlation expected by Longstaff and Schwartz (1995). However, Elton et al. (2001) point out that Duffee's analysis ignores the effects of the tax differential between U.S. Treasury and corporate bonds. Canadian bonds have no such tax differential, yet, after controlling for callability, we find that the correlation between interest rates and corporate bond spreads remains negligible. We also find a significant negative relationship for callable bonds with this relationship increasing with the moneyness of the call provision. These results are robust under alternate empirical specifications.

Keywords: Bond Yield Spread, Default Risk, Callable Bonds, Corporate Bonds

JEL Classification: G11

Suggested Citation

Jacoby, Gady and Batten, Jonathan A. and Liao, Rose C., A Pure Test for the Elasticity of Yield Spreads (December 2006). IIIS Discussion Paper Series No. 195, Available at SSRN: https://ssrn.com/abstract=958018 or http://dx.doi.org/10.2139/ssrn.958018

Gady Jacoby (Contact Author)

University of Manitoba - Department of Accounting and Finance

Faculty of Management
Winnipeg, MB R3T 5V4
Canada

Seton Hall University ( email )

400 S Orange Avenue
South Orange, NJ 07079
United States

Jonathan A. Batten

RMIT University ( email )

Level 12, 239 Bourke Street
Melbourne, Victoria
Australia

HOME PAGE: http://https://www.rmit.edu.au/contact/staff-contacts/academic-staff/b/batten-professor-jonathan

The University of Sydney ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

HOME PAGE: http://https://business.sydney.edu.au/staff/jonathan.batten

Rose C. Liao

Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics ( email )

1 Washington Park
Newark, NJ 07102
United States

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