Credit Spread Changes and Volatility Spillover Effects
The purpose of this paper is to investigate the
influence of a number of variables on the conditional mean and
conditional variance of credit spread changes. The empirical analysis
in this paper is conducted within the context of bivariate GARCH-in-
Mean models, using the so-called BEKK parameterization. We show
that credit spread changes are determined by interest-rate and equityreturn
variables, which is in line with theory as provided by the
structural models of default. We also identify the credit spread
change volatility as an important determinant of credit spread
changes, and provide evidence on the transmission of volatility
between the variables under study.
[1] Y. Baba, R. Engle, D. Kraft, and K. Kroner, "Multivariate simultaneous
generalized ARCH," Mimeo, Department of Economics, University of
California, San Diego, 1990.
[2] H. Bierens, J. Huang, and W. Kong, "An econometric model of credit
spreads with rebalancing, ARCH and jump effects," Working paper,
Penn State University, 2003.
[3] F. Black, and M. Scholes, "The pricing of options and corporate
liabilities," Journal of Political Economy, vol. 81, pp. 637-654, 1973.
[4] T. Bollerslev, and J. Wooldridge, "Quasi-maximum likelihood
estimation and inference in dynamic models with time-varying
covariances," Econometric Reviews, vol. 11, pp. 143-172, 1992.
[5] C. Broyden, "A class of methods for solving nonlinear simultaneous
equations," Mathematics of Computation, vol. 19, pp. 577-593, 1965.
[6] C. Broyden, "Quasi-Newton methods and their application to function
minimisation," Mathematics of Computation, vol. 21, pp. 368-381, 1967.
[7] J. Campbell, and G. Taksler, "Equity volatility and corporate bond
yields," Journal of Finance, vol. 58, pp. 2321-2349, 2003.
[8] R.-R. Chen, and L. Scott, "Maximum likelihood estimation for a
multifactor equilibrium model of the term structure of interest rates,"
Journal of Fixed Income, vol. 3, pp. 14-31, 1993.
[9] P. Collin-Dufresne, R. Goldstein, and S. Martin, "The determinants of
credit spread changes," Journal of Finance, vol. 56, pp. 2177-2207,
2001.
[10] M. Cremers, J. Driessen, P. Maenhout and D. Weinbaum, "Individual
stock-option prices and credit spreads," Working paper, Yale School of
Management, 2005.
[11] G. Delianedis, and R. Geske, "The components of corporate credit
spreads: Default, recovery, tax, jumps, liquidity, and market factors,"
Working paper, The Anderson School at UCLA, 2001.
[12] G. Duffee, "The relation between Treasury yields and corporate bond
yield spreads," Journal of Finance, vol. 53, pp. 2225-2241, 1998.
[13] G. Elliott, T. Rothenberg, and J. Stock, "Efficient tests for an
autoregressive unit root," Econometrica, vol. 64, pp. 813-836, 1996.
[14] E. Elton, M. Gruber, D. Agrawal, and C. Mann, "Explaining the rate
spread on corporate bonds," Journal of Finance, vol. 56, pp. 247-277,
2001.
[15] R. Engle, and K. Kroner, "Multivariate simultaneous generalised
ARCH," Econometric Theory, vol. 11, pp. 122-150, 1995.
[16] Y. Eom, J. Helwege, and J.-Z. Huang, "Structural models of corporate
bond pricing: An empirical analysis," The Review of Financial Studies,
vol. 17, pp. 499-544, 2004.
[17] T. Flavin, and M. Limosani, "Fiscal, monetary policy and the conditional
risk premium in short-term interest rate differentials: An application of
Tobin's portfolio theory," International Review of Economics &
Finance, vol. 16, pp. 101-112, 2007.
[18] R. Fletcher, and M. Powell, "A rapidly convergent descent method for
minimization," Computer Journal, vol. 7, pp. 149-154, 1963.
[19] J. Huang, and M. Huang, "How much of the corporate-Treasury yield
spread is due to credit risk?," Working paper, Stanford University, 2003.
[20] J. Huang, and W. Kong, "Explaining credit spread changes: Some new
evidence from option-adjusted spreads of bond indexes," Working
paper, Pennsylvania State University, 2003.
[21] R. Jarrow, D. Lando, and S. Turnbull, "A Markov model for the term
structure of credit risk spreads," The Review of Financial Studies, vol.
10, pp. 481-523, 1997.
[22] R. Jarrow, and S. Turnbull, "Pricing derivatives on financial securities
subject to credit risk," Journal of Finance, vol. 50, pp. 53-85, 1995.
[23] S. Kwan, "Firm-specific information and the correlation between
individual stocks and bonds," Journal of Financial Economics, vol. 40,
pp. 63-80, 1996.
[24] D. Kwiatkowski, P. Phillips, P. Schmidt, and Y. Shin, "Testing the null
hypothesis of stationarity against the alternative of a unit root," Journal
of Econometrics, vol. 54, pp. 159-178, 1992.
[25] R. Litterman, and J. Scheinkman, "Common factors affecting bond
returns," Journal of Fixed Income, vol. 1, pp. 54-61, 1991.
[26] F. Longstaff, and E. Schwartz, "A simple approach to valuing risky fixed
and floating rate debt," Journal of Finance, vol. 50, pp. 789-819, 1995.
[27] R. Merton, "On the pricing of corporate debt: The risk structure of
interest rates," Journal of Finance, vol. 29, pp. 449-470, 1974.
[28] E. Zivot, and D. Andrews, "Further evidence on the great crash, the oilprice
shock, and the unit-root hypothesis," Journal of Business &
Economic Statistics, vol. 10, pp. 251-270, 1992.
[1] Y. Baba, R. Engle, D. Kraft, and K. Kroner, "Multivariate simultaneous
generalized ARCH," Mimeo, Department of Economics, University of
California, San Diego, 1990.
[2] H. Bierens, J. Huang, and W. Kong, "An econometric model of credit
spreads with rebalancing, ARCH and jump effects," Working paper,
Penn State University, 2003.
[3] F. Black, and M. Scholes, "The pricing of options and corporate
liabilities," Journal of Political Economy, vol. 81, pp. 637-654, 1973.
[4] T. Bollerslev, and J. Wooldridge, "Quasi-maximum likelihood
estimation and inference in dynamic models with time-varying
covariances," Econometric Reviews, vol. 11, pp. 143-172, 1992.
[5] C. Broyden, "A class of methods for solving nonlinear simultaneous
equations," Mathematics of Computation, vol. 19, pp. 577-593, 1965.
[6] C. Broyden, "Quasi-Newton methods and their application to function
minimisation," Mathematics of Computation, vol. 21, pp. 368-381, 1967.
[7] J. Campbell, and G. Taksler, "Equity volatility and corporate bond
yields," Journal of Finance, vol. 58, pp. 2321-2349, 2003.
[8] R.-R. Chen, and L. Scott, "Maximum likelihood estimation for a
multifactor equilibrium model of the term structure of interest rates,"
Journal of Fixed Income, vol. 3, pp. 14-31, 1993.
[9] P. Collin-Dufresne, R. Goldstein, and S. Martin, "The determinants of
credit spread changes," Journal of Finance, vol. 56, pp. 2177-2207,
2001.
[10] M. Cremers, J. Driessen, P. Maenhout and D. Weinbaum, "Individual
stock-option prices and credit spreads," Working paper, Yale School of
Management, 2005.
[11] G. Delianedis, and R. Geske, "The components of corporate credit
spreads: Default, recovery, tax, jumps, liquidity, and market factors,"
Working paper, The Anderson School at UCLA, 2001.
[12] G. Duffee, "The relation between Treasury yields and corporate bond
yield spreads," Journal of Finance, vol. 53, pp. 2225-2241, 1998.
[13] G. Elliott, T. Rothenberg, and J. Stock, "Efficient tests for an
autoregressive unit root," Econometrica, vol. 64, pp. 813-836, 1996.
[14] E. Elton, M. Gruber, D. Agrawal, and C. Mann, "Explaining the rate
spread on corporate bonds," Journal of Finance, vol. 56, pp. 247-277,
2001.
[15] R. Engle, and K. Kroner, "Multivariate simultaneous generalised
ARCH," Econometric Theory, vol. 11, pp. 122-150, 1995.
[16] Y. Eom, J. Helwege, and J.-Z. Huang, "Structural models of corporate
bond pricing: An empirical analysis," The Review of Financial Studies,
vol. 17, pp. 499-544, 2004.
[17] T. Flavin, and M. Limosani, "Fiscal, monetary policy and the conditional
risk premium in short-term interest rate differentials: An application of
Tobin's portfolio theory," International Review of Economics &
Finance, vol. 16, pp. 101-112, 2007.
[18] R. Fletcher, and M. Powell, "A rapidly convergent descent method for
minimization," Computer Journal, vol. 7, pp. 149-154, 1963.
[19] J. Huang, and M. Huang, "How much of the corporate-Treasury yield
spread is due to credit risk?," Working paper, Stanford University, 2003.
[20] J. Huang, and W. Kong, "Explaining credit spread changes: Some new
evidence from option-adjusted spreads of bond indexes," Working
paper, Pennsylvania State University, 2003.
[21] R. Jarrow, D. Lando, and S. Turnbull, "A Markov model for the term
structure of credit risk spreads," The Review of Financial Studies, vol.
10, pp. 481-523, 1997.
[22] R. Jarrow, and S. Turnbull, "Pricing derivatives on financial securities
subject to credit risk," Journal of Finance, vol. 50, pp. 53-85, 1995.
[23] S. Kwan, "Firm-specific information and the correlation between
individual stocks and bonds," Journal of Financial Economics, vol. 40,
pp. 63-80, 1996.
[24] D. Kwiatkowski, P. Phillips, P. Schmidt, and Y. Shin, "Testing the null
hypothesis of stationarity against the alternative of a unit root," Journal
of Econometrics, vol. 54, pp. 159-178, 1992.
[25] R. Litterman, and J. Scheinkman, "Common factors affecting bond
returns," Journal of Fixed Income, vol. 1, pp. 54-61, 1991.
[26] F. Longstaff, and E. Schwartz, "A simple approach to valuing risky fixed
and floating rate debt," Journal of Finance, vol. 50, pp. 789-819, 1995.
[27] R. Merton, "On the pricing of corporate debt: The risk structure of
interest rates," Journal of Finance, vol. 29, pp. 449-470, 1974.
[28] E. Zivot, and D. Andrews, "Further evidence on the great crash, the oilprice
shock, and the unit-root hypothesis," Journal of Business &
Economic Statistics, vol. 10, pp. 251-270, 1992.
@article{"International Journal of Business, Human and Social Sciences:63055", author = "Thomas I. Kounitis", title = "Credit Spread Changes and Volatility Spillover Effects", abstract = "The purpose of this paper is to investigate the
influence of a number of variables on the conditional mean and
conditional variance of credit spread changes. The empirical analysis
in this paper is conducted within the context of bivariate GARCH-in-
Mean models, using the so-called BEKK parameterization. We show
that credit spread changes are determined by interest-rate and equityreturn
variables, which is in line with theory as provided by the
structural models of default. We also identify the credit spread
change volatility as an important determinant of credit spread
changes, and provide evidence on the transmission of volatility
between the variables under study.", keywords = "Credit spread changes, GARCH-in-Mean models,
structural framework, volatility transmission.", volume = "1", number = "6", pages = "278-6", }
