The Credit Spread Puzzle Does Exist—But Is It Really a Puzzle?

Abstract

Much academic research shows that the spreads at which corporate bonds trade above a similar default-free asset are too large compared with what is predicted by a standard structural model. This finding has given rise to the so-called Credit Spread Puzzle. Recent research points to a few statistical biases in the previous findings and conclude that the puzzle is not as strong as previous papers have indicated. In this article, the author controls for these biases and shows that the puzzle is highly present in a sample from the Norwegian fixed-income market in the 2008–2013 period. On average, only 28% of the spreads are explained by the structural model. The question is not whether the puzzle exists but rather, is it correct to call this a puzzle?

TOPICS: Fixed income and structured finance, developed