Credit Spread Changes in the Euro Area - An Empirical Study of the Relationship Between Interest Rates and Credit Spreads in the Euro-denominated Corporate Bond Market

Abstract

The behaviour of credit spreads is of importance for a wide array of stakeholders. We test the relationship between changes in risk-free interest rates and credit spreads in European bond market by running OLS regressions using weekly European market data for investment grade and non-investment grade bond indices. We collect data from 1999 – 2017 and subsequently separate the time series into three periods in an effort to examine differences in different market settings. The findings strengthen that of previous research and support an inverse relationship between changes in interest rates and credit spreads. Furthermore, we detect the coefficients being different in the different periods and attribute part of the change to the growth of European bond market. We also find the residuals from our regressions being heavily correlated and suspect, as previous researchers, that corporate bond spreads carry a large systematic component.