The Myth of the Credit Spread Puzzle

Peter Feldhütter, Stephen M. Schaefer

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Abstract

Are standard structural models able to explain credit spreads on corporate bonds? In contrast to much of the literature, we find that the Black-Cox model matches the level of investment-grade spreads well. Model spreads for speculative-grade debt are too low, and we find that bond illiquidity contributes to this underpricing. Our analysis makes use of a new approach for calibrating the model to historical default rates that leads to more precise estimates of investment-grade default probabilities.
Original languageEnglish
JournalReview of Financial Studies
Volume31
Issue number8
Pages (from-to)2897-2942
Number of pages46
ISSN0893-9454
DOIs
Publication statusPublished - Aug 2018

Keywords

  • Asset pricing
  • Trading volume
  • Bond interest rates
  • Panel data models
  • Spatio-temporal models
  • Contingent pricing
  • Futures pricing

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