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Stock market performance and the term structure of credit spreads


Demchuk, Andriy; Gibson, Rajna (2006). Stock market performance and the term structure of credit spreads. Journal of Financial and Quantitative Analysis, 41(4):863-887.

Abstract

We build a structural two-factor model of default where the stock market index is one of the stochastic factors. We allow the firm to adjust its leverage ratio in response to changes in the business climate for which the past performance of the stock market index acts as a proxy. We assume that the firm's log-leverage ratio follows a mean-reverting process and that the past performance of the stock index negatively affects the firms target leverage ratio. We show that for most credit ratings our model may explain actual yield spreads better than other well-known structural credit risk models. Also, our model shows that the past performance of the stock index returns and the firm's assets beta have a significant impact on credit spreads. Hence, our model can explain why credit spreads may be different within the same credit rating groups and why spreads are lower during economic expansions and higher during recessions

Abstract

We build a structural two-factor model of default where the stock market index is one of the stochastic factors. We allow the firm to adjust its leverage ratio in response to changes in the business climate for which the past performance of the stock market index acts as a proxy. We assume that the firm's log-leverage ratio follows a mean-reverting process and that the past performance of the stock index negatively affects the firms target leverage ratio. We show that for most credit ratings our model may explain actual yield spreads better than other well-known structural credit risk models. Also, our model shows that the past performance of the stock index returns and the firm's assets beta have a significant impact on credit spreads. Hence, our model can explain why credit spreads may be different within the same credit rating groups and why spreads are lower during economic expansions and higher during recessions

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:National licences > 142-005
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Accounting
Social Sciences & Humanities > Finance
Social Sciences & Humanities > Economics and Econometrics
Language:English
Date:1 December 2006
Deposited On:01 Nov 2018 17:12
Last Modified:31 Jul 2020 02:16
Publisher:Cambridge University Press
ISSN:0022-1090
OA Status:Green
Publisher DOI:https://doi.org/10.1017/s0022109000002672
Related URLs:https://www.swissbib.ch/Search/Results?lookfor=nationallicencecambridge101017S0022109000002672 (Library Catalogue)

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