Predicting Credit Spreads

by C.N.V. Krishnan of Case Western Reserve University,
Peter H. Ritchken of Case Western Reserve University, and
James B. Thomson of the Federal Reserve Bank of Cleveland

February 5, 2008

Abstract: Predictions of firm-level credit spreads based on the current spot and forward credit spreads can be significantly improved upon by using the information contained in the shape of the credit-spread curve. However, the current credit-spread curve is not a sufficient statistic for predicting future out-of-sample credit spreads; predictions can be significantly improved upon by exploiting the information contained in the shape of the riskless yield curve. In the presence of credit-spread and riskless factors, other macroeconomic, marketwide, and firm-specific-risk variables do not significantly improve predictions of credit spreads. Current credit-spread and riskless-yield curves impound essentially all marketwide and firm-specific information necessary for predicting future credit spreads. Our results have important implications for credit-spreads modeling.

Keywords: Term Structure of Credit Spreads, Forecasting Future Credit Spreads.

Published in: Journal of Financial Intermediation, Vol. 19, No. 4, (October 2010), pp. 529-563.

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