Testing for the Elasticity of Corporate Yield Spreads

51 Pages Posted: 2 Mar 2007

See all articles by Jonathan A. Batten

Jonathan A. Batten

RMIT University; The University of Sydney

Gady Jacoby

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

Rose C. Liao

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

Date Written: March 1, 2007

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, the correlation between riskless interest rates and corporate bond spreads remains negligible. We also find a significant negative relationship for callable bonds that increases with the moneyness of the call provision. These results are robust under alternate empirical specifications. Our results therefore provide support for reduced-form models that explicitly define a default hazard process and untie the relation between the firm's asset value and default probability.

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

JEL Classification: G11, G15

Suggested Citation

Batten, Jonathan A. and Jacoby, Gady and Liao, Rose C., Testing for the Elasticity of Corporate Yield Spreads (March 1, 2007). HKUST Business School Research Paper No. 07-03, Available at SSRN: https://ssrn.com/abstract=967627 or http://dx.doi.org/10.2139/ssrn.967627

Jonathan A. Batten (Contact Author)

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

Gady Jacoby

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

Rose C. Liao

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

1 Washington Park
Newark, NJ 07102
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
185
Abstract Views
1,187
rank
184,125
PlumX Metrics