Explaining Credit Spread Changes: New Evidence from Option-Adjusted Bond Indexes

FALL 2003 This is an examination of the determinants of corporate bond credit spreads using both weekly and monthly option-adjusted spreads for nine Merrill Lynch corporate bond indexes from January 1997 through July 2002. The Russell 2000 index historical return volatility and the Conference Board composite leading and coincident economic indicators have significant power in explaining credit spread changes, especially for high-yield indexes. These three variables plus the interest rate level, the historical interest rate volatility, the yield curve slope, the Russell 2000 index return, and a high-minuslow factor together can explain more than 40% of credit spread changes for five bond indexes. These eight variables together can explain 67.68% and 60.82% of credit spread changes for the B and BBrated indexes.