Humpbacks in Credit Spreads

Journal Of Investment Management (JOIM), Third Quarter 2008

Posted: 30 Jan 2009 Last revised: 12 Jul 2010

See all articles by Deepak Agarwal

Deepak Agarwal

affiliation not provided to SSRN

Jeffrey Bohn

State Street Corporate; University of California, Berkeley - Center for Risk Management Research

Date Written: October 6, 2008

Abstract

Models of credit valuation generally predict a hump-shaped spread term structure for low quality issuers. This is understood to be driven by the shape of the underlying conditional default probabilities curve. We show that (a) recovery assumptions and (b) deviation of bond's price from its par value can also drive different term structure shapes. Our analysis resolves conflicting empirical evidence on the shape of speculative grade spread curves and explains the related existing theoretical results. On examining a large set of speculative grade bonds and credit default swaps, we find evidence that par-spread term structures are likely to be downward sloping as credit quality deteriorates sufficiently.

Keywords: credit, spread, term structure, recovery, humpbacks

JEL Classification: G00

Suggested Citation

Agarwal, Deepak and Bohn, Jeffrey and Bohn, Jeffrey, Humpbacks in Credit Spreads (October 6, 2008). Journal Of Investment Management (JOIM), Third Quarter 2008, Available at SSRN: https://ssrn.com/abstract=1279699

Deepak Agarwal (Contact Author)

affiliation not provided to SSRN ( email )

Jeffrey Bohn

University of California, Berkeley - Center for Risk Management Research ( email )

581 Evans Hall
Berkely, CA
United States

State Street Corporate ( email )

1 Lincoln Street
Boston, MA 02111
United States

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