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Credit Spreads and Interest Rates: A Cointegration ApproachCharles Morris |
Abstract This paper uses cointegration to model the time-series of corporate and government bond rates. We show that corporate rates are cointegrated with government rates and the relation between credit spreads and Treasury rates depends on the time horizon. In the short-run, an increase in Treasury rates causes credit spreads to narrow. This effect is reversed over the long-run and higher rates cause spreads to widen. The positive long-run relation between spreads and Treasuries is inconsistent with prominent models for pricing corporate bonds, analyzing capital structure, and measuring the interest rate sensitivity of corporate bonds. Charles Morris is a vice president and economist at the Federal Reserve Bank of Kansas
City. Robert Neal is an associate professor of finance at the Kelley School of Business,
Indiana University. Doug Rolph is a graduate student in the School of Business, University
of Washington. The authors thank Mike Hemler, Sharon Kozicki, Pu Shen, Richard Shockley,
and the seminar participants at Indiana University and the Federal Reserve Bank of Kansas
City. They also thank Klara Parrish for research assistance. The views expressed in this
paper are those of the authors and do not necessarily represent those of the Federal
Reserve Bank of Kansas City or the Federal Reserve System.
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