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The determinants of credit spread changes in Japan

February 2007
Shinsuke Ohyama*1
Takuya Sugimoto*2

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Abstract

In this paper, we examine the relationship between credit spread changes in Japan and financial and macroeconomic variables such as the risk-free interest rate and stock price indices. We use a model that belongs to the class of so-called structural models for corporate bond pricing originally developed by Merton (1974) and extended by Longstaff and Schwartz (1995) among others. Our empirical results indicate that credit spreads in Japan are negatively correlated with the risk-free interest rate and with corporate financial conditions (which stand proxy for the market valuations of firms). The magnitude of such correlations increases as the credit ratings of the bond issuers decline. These results are consistent with the implications of structural models and with the related literatures in the U.S. and Europe. We also find that credit spreads in Japan are positively correlated with the implied volatility of interest rates. In other words, an increase in uncertainty about future interest-rate contributes to the widening in credit spreads.

We thank Fumihito Gotoh (UBS Securities Japan Ltd.), Yasunobu Katsuki (Mizuho Securities Co., Ltd.), Koei Takahashi (Nomura Securities Co., Ltd.), Hidetoshi Ohashi (Morgan Stanley Japan Securities Co., Ltd.), and Kiyotoshi Yasuda (JPMorgan Securities Japan Co., Ltd.) for their insightful comments and suggestions. This research is also indebted to discussions with and comments from our colleagues at the Bank of Japan, especially Yoshifumi Hisada, Yuko Kawai, Keiji Kono, Teppei Nagano, Nobuyuki Oda, and Youichi Ueno. The views expressed here are ours alone, and do not necessarily reflect those of the Bank of Japan or other organizations.

  • *1 Financial Markets Department, Bank of Japan
    e-mail:shinsuke.ooyama@boj.or.jp
  • *2 Morgan Stanley Japan Securities Co. Ltd.
    (formerly Financial Markets Department, Bank of Japan)

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