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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Treasury Yields and Corporate Bond Yield Spreads: An Empirical Analysis
Gregory R. Duffee

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) | Full paper (450 KB Postscript)

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Last update: July 16, 1997