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Testing the Elasticity of Corporate Yield Spreads

Published online by Cambridge University Press:  01 June 2009

Gady Jacoby ,
Rose C. Liao  and
Jonathan A. Batten
Gady Jacoby
Affiliation:
Asper School of Business, University of Manitoba, 181 Freedman Crescent, Winnipeg, MB, Canada, R3T 5V4 and Seton Hall University. [email protected]
Rose C. Liao
Affiliation:
Fisher College of Business, Ohio State University, 2100 Neil Ave., Columbus, OH 43210 and Rutgers University. [email protected]
Jonathan A. Batten
Affiliation:
Hong Kong University of Science & Technology, Clear Water Bay, Kowloon, Hong Kong. [email protected]
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Abstract

What drives the compensation demanded by investors in risky bonds? Longstaff and Schwartz (1995) predict that one key factor is the time-varying negative correlation between interest rates and the yield spreads on corporate bonds. However, the effects of callability and taxes also need to be considered in empirical analyses. Canadian bonds have no tax effects, yet, after controlling for callability, the correlation between riskless interest rates and corporate bond spreads remains negligible. Our results 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.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 3 , June 2009 , pp. 641 - 656
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

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