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Bridge over ocean
1 March 2007 Financial Analysts Journal Volume 63, Issue 2

Understanding Changes in Corporate Credit Spreads

  1. Doron Avramov
  2. Gergana Jostova
  3. Alexander Philipov

New evidence is reported on the empirical success of structural models in
explaining changes in corporate credit risk. A parsimonious set of common
factors and company-level fundamentals, inspired by structural models, was found
to explain more than 54 percent (67 percent) of the variation in credit-spread
changes for medium-grade (low-grade) bonds. No dominant latent factor was
present in the unexplained variation. Although this set of factors had lower
explanatory power among high-grade bonds, it did capture most of the systematic
variation in credit-spread changes in that category. It also subsumed the
explanatory power of the Fama and French factors among all grade classes.

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