Is the credit spread puzzle a myth?

Jennie Bai, Robert S. Goldstein, Fan Yang

Research output: Contribution to journalArticlepeer-review

2 Scopus citations

Abstract

We revisit Feldhütter and Schaefer (FS, 2018), who report evidence of a “credit spread puzzle” for high-yield but not investment-grade bonds. We show their results are reversed when their model is calibrated to market values of debt (as required by theory) rather than book values. We then demonstrate that using credit spreads rather than historical default rates to identify the default boundary provides the statistical power necessary to reject their assumption that firm dynamics follow geometric Brownian motion. A large market price of jump risk is required to match historical default rates, which generates a credit spread puzzle for investment-grade but not high-yield bonds.

Original languageEnglish (US)
Pages (from-to)297-319
Number of pages23
JournalJournal of Financial Economics
Volume137
Issue number2
DOIs
StatePublished - Aug 2020

Keywords

  • Credit spread puzzle
  • Structural models
  • Tail risk

Fingerprint Dive into the research topics of 'Is the credit spread puzzle a myth?'. Together they form a unique fingerprint.

Cite this