Treasury Yields and Corporate Bond Yield Spreads: An empirical analysis
by Gregory R. Duffee of the Federal Reserve Board of Governors
Abstract: This paper empirically examines the relation between the Treasury term structure and spreads of investment grade corporate bond yields over Treasuries. I find that non-callable bond yield spreads fall when the level of the Treasury term structure rises. The extent of this decline depends on the initial credit quality of the bond; the decline is small for Aaa-rated bonds and large for Baa-rated bonds. The role of the business cycle in generating this pattern is explored, as is the link between yield spreads and default risk. I also argue that yield spreads based on commonly-used bond yield indexes are contaminated in two important ways. The first is that they are "refreshed" indexes, which hold credit ratings constant over time; the second is that they usually are constructed with both callable and non-callable bonds. The impact of both of these problems is examined.
Previously titled: "The Variation of Default Risk with Treasury Yields"