Bridge over ocean
1 May 2003 Financial Analysts Journal Volume 59, Issue 3

Nondefault Components of Investment-Grade Bond Spreads

  1. James H. Dignan

Traditionally, attempts at decomposing the spread between risk-free debt and corporate debt has focused exclusively on default risk. This focus continues despite the fact that the data indicate that the required spreads for higher-rated corporate bonds are normally far smaller than the spreads available in the market. This article challenges the traditional notion of an “excess spread” and, instead, attributes the additional spread to non-default-related factors, such as liquidity and spread volatility. The costs associated with both liquidity and spread volatility are examined, and a framework is provided for the investor to calculate adequate compensation for such costs.

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