Testing the elasticity of corporate yield spreads

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

*Corresponding author for this work

Research output: Contribution to journalArticle

13 Citations (Scopus)

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 firms asset value and default probability.

Original languageEnglish
Pages (from-to)641-656
Number of pages16
JournalJournal of Financial and Quantitative Analysis
Volume44
Issue number3
DOIs
Publication statusPublished - Jun 2009

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