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.