The Factors Affecting Corporate Bond Spreads

In this paper, we estimate the impact of fundamental economic factors on corporate bond spreads in Israel. Using a database that includes all tradable corporate bonds in Israel in 2008–20, we examine if, when, and in what bond groups there was a prolonged deviation of the actual spread from the spread forecast by the fundamental factors. We find that in the years prior to the crisis of 2008, and in the year prior to the European sovereign debt crisis in 2011, more than 20 percent of the corporate bond market value traded at spreads smaller than those forecast based on the fundamental factors. In addition, we find that aggregate flows to corporate bond mutual funds contributed to accentuating the trends of deviation from the forecast spread existing in the market, primarily in the period after the 2008 crisis. The results indicate that rapid aggregate inflows to mutual funds contribute to increasing the vulnerability of the corporate bond market. Should corporate bond spreads deviate from those forecasted by fundamental economic factors, such aggregate flows are liable to intensify rising-price trends, and when the trend changes— to exacerbate the declining-price trend.