Keywords: Yields, spreads, default, insolvency, liquidity
Abstract: In this paper, we first document some stylized facts
about very short-term and long-term corporate yield spreads.
We find that short-term spreads are sizable, and the correlations
between many firms' short-term and long-term yield spreads are
at times negative. We then develop a structural model
that generates levels and correlations of short-term and long-term
spreads that are more consistent with what we observe. The
model allows for the possibility of payment delays when a firm's
liquid asset position deteriorates. Payment delays generate sizable
short-term debt spreads because the realized returns on short-term
investments are very sensitive to an increase in the
holding period. The presence of liquidity risk can also explain
negative correlations between short- and long-term spreads
because liquidity risk is imperfectly correlated with
insolvency risk. Using firm-level data, we provide empirical
evidence that liquid assets holdings help predict short-term spreads,
but not long-term spreads.
Full paper (248 KB PDF)
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Last update: October 10, 2002