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Aalto University School of Business Master's Theses are now in the Aaltodoc publication archive (Aalto University institutional repository)
School of Business | Department of Finance | Finance | 2014
Thesis number: 13775
Empirical analysis of relation between credit premia and government yield term structure
Author: Pehkonen, Pauli
Title: Empirical analysis of relation between credit premia and government yield term structure
Year: 2014  Language: eng
Department: Department of Finance
Academic subject: Finance
Index terms: rahoitus; financing; joukkovelkakirjat; bonds and debentures; yritykset; companies; luotto; credit; korko; interest
Pages: 69
Key terms: corporate bond spread; yritysjoukkovelkakirjan luottopreemio; credit default swap premium; credit default swap -preemio; credit premium; luottopreemio; yield term structure level; korkokäyrän taso; yield term structure slope; korkokäyrän jyrkkyys; yield term structure convexity; korkokäyrän konveksisuus
This Master's thesis contributes to the existing literature by studying the relation between credit premia - corporate bond spreads and corporate credit default swap (CDS) premia - and government yield term structure components, which focus on the level and the slope. My sample centers on the Euro-denominated investment grade credit premia by using Markit's iBoxx corporate bond indices and iTraxx corporate CDS indices. For bond indices the time period of study is September 2002 - October 2013, and for the CDS indices the time period is April 2005 - October 2013.

For the relation between credit premia and the level of government bond yield curve I find statistically and economically significant results throughout the rating and maturity spectrum. One unique feature of this study compared to prior literature is the division of the slope of the government yield curve to investigate separately its short-end and long-end to credit premia. This provides interesting results in particular due to historically low reference rate levels during the study period and the recent popularity of quantitative easing as an unconventional method of monetary policy. For the short-term slope of the government yield curve, the results indicate a significant relation for bond spreads except for AAA-rated bonds as well as a statistically less reliable relation with poor consistency for CDS premia. For the long-term slope, the relation appears significant for long-maturity corporate bond and CDS spreads.

Additionally, this paper contributes to the literature by providing findings on the relative explanatory power of government yield curve components and the causality between credit premia and government yields. The level appears to have the greatest relative explanatory power on credit premia of the government yield curve components, with also the short-term slope having significant explanatory power on bond spreads. Moreover, the causality tests show that the changes in the long-term slope cause corporate bond spread changes, with the AAA-rated bond spreads indicating an opposing causality. Changes in CDS spreads appear to be caused by the short-term slope. Furthermore, this study proves that the relations between the government yield curve and credit premia have strengthened during the recent recession period.
Master's theses are stored at Learning Centre in Otaniemi.