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I. Corporate Yield Spreads
In this section, we examine corporate yield spreads. We initially discuss
the data used. Then we discuss why yield spreads should be measured as the
difference in yield to maturity on zero-coupon bonds ~rather than coupon
bonds! and how these rates can be estimated. Next, we examine and discuss
the pattern of spreads. Finally, we compare the price of corporate bonds
computed from our estimated spots with actual prices as a way of judging
the reasonableness of our estimates.
A. Data
Our bond data are extracted from the Lehman Brothers Fixed Income
Database distributed by Warga ~1998!. This database contains monthly price,
accrued interest, and return data on all investment-grade corporate and government
bonds. In addition, the database contains descriptive data on bonds,
including coupons, ratings, and callability.
A subset of the data in the Warga database is used in this study. First, all
bonds that were matrix priced rather than trader priced are eliminated from
the sample.5 Employing matrix prices might mean that all our analysis uncovers
is the rule used to matrix-price bonds rather than the economic influences
at work in the market. Eliminating matrix-priced bonds leaves us
with a set of prices based on dealer quotes. This is the same type of data as
that contained in the standard academic source of government bond data:
the CRSP government bond file.6
Next, we eliminate all bonds with special features that would result in
their being priced differently. This means we eliminate all bonds with options
~e.g., callable bonds or bonds with a sinking fund!, all corporate f loating
rate debt, bonds with an odd frequency of coupon payments, government
flower bonds, and inf lation-indexed government bonds.
In addition, we eliminate all bonds not included in the Lehman Brothers
bond indexes, because researchers in charge of the database at Lehman Brothers
indicate that the care in preparing the data was much less for bonds not
included in their indexes. This results in eliminating data for all bonds with
a maturity of less than one year.
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