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Testing the Elasticity of Corporate Yield Spreads

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  • Jacoby, Gady
  • Liao, Rose C.
  • Batten, Jonathan A.

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.

Suggested Citation

  • Jacoby, Gady & Liao, Rose C. & Batten, Jonathan A., 2009. "Testing the Elasticity of Corporate Yield Spreads," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(3), pages 641-656, June.
    • Handle: RePEc:cup:jfinqa:v:44:y:2009:i:03:p:641-656_99
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    Citations

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    Cited by:

    1. Contessi, Silvio & De Pace, Pierangelo & Guidolin, Massimo, 2020. "Mildly explosive dynamics in U.S. fixed income markets," European Journal of Operational Research, Elsevier, vol. 287(2), pages 712-724.
    2. Chi-Fai Lo & Cho-Hoi Hui, 2016. "Pricing corporate bonds with interest rates following double square-root process," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(03), pages 1-31, September.
    3. Afik, Zvika & Jacoby, Gady & Stangeland, David & Wu, Zhenyu, 2019. "The make-whole and Canada-call provisions: A case of cross-country spillover of financial innovation," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 61(C), pages 120-127.
    4. Sun, David & Tsai, Shih-Chuan, 2013. "Diversifying Risks in Bond Portfolios: A Cross-border Approach," MPRA Paper 44767, University Library of Munich, Germany, revised 09 Jan 2014.
    5. Audzeyeva, Alena & Schenk-Hoppé, Klaus Reiner, 2010. "The role of country, regional and global market risks in the dynamics of Latin American yield spreads," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(4), pages 404-422, October.
    6. Batten, Jonathan A. & Jacoby, Gady & Liao, Rose C., 2014. "Corporate yield spreads and real interest rates," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 89-100.
    7. Vijay A. Murik, 2013. "Bond pricing with a surface of zero coupon yields," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(2), pages 497-512, June.
    8. Docherty, Paul & Easton, Steve, 2018. "State-varying illiquidity risk in sovereign bond spreads," Pacific-Basin Finance Journal, Elsevier, vol. 50(C), pages 235-248.
    9. Xueying Zhang & Shansheng Gao & Jian Jiao, 2018. "Moral Hazard Effects of Corporate Bond Guarantee Purchases: Empirical Evidence from China," Journal of Economics and Behavioral Studies, AMH International, vol. 10(5), pages 100-115.
    10. Chi-Fai Lo & Cho-Hoi Hui, 2016. "Pricing Corporate Bonds With Interest Rates Following Double Square-root Process," Working Papers 112016, Hong Kong Institute for Monetary Research.

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