Working Paper

What Drives the Cross-Section of Credit Spreads?: A Variance Decomposition Approach

Abstract: I decompose the cross-sectional variation of the credit spreads for corporate bonds into changing expected returns and changing expectation of credit losses with a model-free method. Using a log-linearized pricing identity and a vector autoregression applied to micro-level data from 1973 to 2011, I find that the expected credit loss component and the excess return component each explains about half of the variance of the credit spreads. Unlike the market-level findings in Gilchrist and Zakrajsek (2012), at the firm level, the expected credit loss is volatile and affects the firms' investment decision more than the expected excess returns.

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2014-08-02

Number: 2014-62

Pages: 65 pages