Econometrics and Finance Seminar: Peter Feldhutter

The Myth of the Credit Spread Puzzle

Peter FELDHUTTER, London Business School

We ask whether standard structural models of credit risk are able to explain credit spreads on corporate bonds and, in contrast to much of the literature, we find that the models match the level of investment grade spreads well. Importantly, we calibrate the models to average default rates measured over a period of almost a century and show in simulations that this long period reduces statistical uncertainty. When using long-run default rates, the models match average investment grade spreads both in recent data and in the long run, as well as the time series variation over the period 1987-2012.