Credit Spreads and Interest Rates: A Cointegration Approach

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Credit Spreads and Interest Rates: A Cointegration Approach

by Charles Morris of the Federal Reserve Bank of Kansas City,
Robert Neal of the Indiana University Kelley School of Business, and
Doug Rolph of the University of Washington School of Business

December 1998

Abstract: This paper uses cointegration to model the time-series of corporate and government bond rates. We show that corporate rates are cointegrated with government rates and the relation between credit spreads and Treasury rates depends on the time horizon. In the short-run, an increase in Treasury rates causes credit spreads to narrow. This effect is reversed over the long-run and higher rates cause spreads to widen. The positive long-run relation between spreads and Treasurys is inconsistent with prominent models for pricing corporate bonds, analyzing capital structure, and measuring the interest rate sensitivity of corporate bonds.

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