Default risk is not the only reason for corporate credit spreads

09/21/05

A new study published in The Journal of Finance finds that while most corporate credit spreads are due to default risk, liquidity related factors also contribute to the cost of debt. By using information from credit default swap premia (a common credit derivative), the authors were able to provide direct measures of the size of the default and nondefault components in corporate yield spreads.

Their findings indicate that the default component does account for the majority of credit spread across all credit ratings. There was, however, also a significant non-default component found for every firm in the study. The study's findings showed little evidence for this non-default component being attributable to varying tax rates, but did show evidence for a strong relation to measures of corporate bond illiquidity.

Source: Eurekalert & others

Last reviewed: By John M. Grohol, Psy.D. on 21 Feb 2009
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