Corporate Credit Risk Changes: Common Factors and Firm-Level Fundamentals

by Doron Avramov of the University of Maryland,
Gergana Jostova of George Washington University, and
Alexander Philipov of American University

September 22, 2005

Abstract: This paper provides new evidence on the empirical success of structural models in explaining corporate credit risk changes. A parsimonious set of common factors and firm-level fundamentals, inspired by structural models, explains more than 54% (67%) of the variation in credit spread changes for medium (low) grade bonds. No dominant latent factor is present in the unexplained variation. While our set of variables has lower explanatory power among high-grade bonds, it does capture most of the systematic variation of credit-spread changes in that category as well. It also subsumes the explanatory power of the Fama and French (1993) factors among all grade classes.

JEL Classification: G10, G11, G12, G14, G15.

Keywords: Credit spread changes, corporate bonds, structural models of default, default risk.

Previously titled: Credit Risk Changes: Common Factors and Firm-Level Fundamentals

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