Abstract: This paper empirically examines the relation
between the Treasury term structure and spreads of investment grade
corporate bond yields over Treasuries. I find that noncallable bond
yield spreads fall when the level of the Treasury term structure
rises. The extent of this decline depends on the initial credit
quality of the bond; the decline is small for Aaa-rated bonds and
large for Baa-rated bonds. The role of the business cycle in
generating this pattern is explored, as is the link between yield
spreads and default risk. I also argue that yield spreads based on
commonly-used bond yield indexes are contaminated in two important
ways. The first is that they are ``refreshed'' indexes, which hold
credit ratings constant over time; the second is that they usually are
constructed with both callable and noncallable bonds. The impact of
both of these problems is examined.
Keywords: Credit risk, yield spreads, business cycles
Full paper (520 KB PDF)
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