Aaltodoc publication archive (Aalto University institutional repository)
School of Business | Department of Finance | Finance | 2012
Thesis number: 12777
Issuer quality and the credit cycle, European evidence
|Title:||Issuer quality and the credit cycle, European evidence|
|Year:||2012 Language: eng|
|Department:||Department of Finance|
|Index terms:||rahoitus; financing; joukkovelkakirjat; bonds and debentures; laatu; quality; riski; risk|
» hse_ethesis_12777.pdf size:3 MB (2794417)
|Key terms:||issuer characteristic spread; velan liikkeellelaskijoiden laatu; issuer quality; velan liikkeellelaskijoiden riskisyys; high yield excess bond returns; roskalainojen ylituotot; European corporate bond markets; Eurooppalaiset joukkovelkakirjamarkkinat|
PURPOSE OF THE STUDY The objective of this thesis is to link patterns of corporate debt financing in Europe to timeseries variation in the pricing of credit risk. The purpose is to show that the credit quality of corporate debt issuers deteriorates during credit booms and this deterioration forecasts low excess returns to corporate bondholders. Further, empirical findings on issuer quality are used to investigate forces driving time-variation in expected corporate bond returns.
DATA AND METHODOLOGY The data sample includes all public non-financial companies which are headquartered in Europe and have a market capitalization of 100 million euros or more. In addition bond data for German Government Bonds and high yield bond indexes are used. The period when the high yield bond index data has been available, 1998-2011, the annually measured company sample consists of 2,015 companies and 14,143 firm years. Quarterly dataset consists of 1,336 companies and 25,567 individual quarterly observations from January 2001 to September 2011. To test the hypotheses, time-series measures of debt issuer quality are formed. After that several ordinary least square (OLS) regressions are conducted in order to test the validity of the hypotheses.
RESULTS The empirical result of this thesis shows that when issuer quality is low high yield corporate bonds subsequently underperform risk-free German Government Bonds of the same maturity. Decline in issuer quality uncovers a striking degree of predictability and often forecast significantly negative excess bond returns at 3- and 4-year horizons over and above traditional proxies for risk premium. These results are difficult to explain using rationally time-varying risk aversion or other drivers of countercyclical risk premium. Instead the findings suggest that intermediary frictions, investor over-extrapolation and reaching for yield drive variations in required high yield bond returns.
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