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The myth of the credit spread puzzle


Review of Financial Studies



Authors / Editors

Feldhutter P;Schaefer S


Publication Year



We ask whether a standard structural model (Black and Cox (1976)) is able to explain credit spreads on corporate bonds and, in contrast to much of the literature, we find that the model matches the level of investment grade spreads well. Model spreads for speculative grade debt are too low and we fi nd that bond illiquidity contributes to this underpricing. Our analysis makes use of a new approach for calibrating the model to historical default rates that leads to much more precise estimates of investment grade default probabilities.


Credit spread puzzle; Structural models; Black-Cox model; Corporate bond spreads; Default probabilities

Available on ECCH


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