Treasury yields and corporate bond yield spreads: An empirical analysis

This paper empirically examines the relation between the Treasury term structure and spreads of investment grade corporate bond yields over Treasuries. I nd 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 Aaarated 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 rst 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. JEL Classi cation: G13 I thank Fischer Black, Ken Singleton and seminar participants at the Federal Reserve Board's Conference on Risk Measurement and Systemic Risk for helpful comments. Nidal Abu-Saba provided valuable research assistance. All errors are my own. The analysis and conclusions of this paper are those of the author and do not indicate concurrence by other members of the research sta , by the Board of Governors, or by the Federal Reserve Banks.