Euro Corporate Bond Risk Factors.
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Abstract
This paper investigates the determinants of credit spread changes in euro-denominated bonds. We adopt a
factor model framework, inspired by the credit risk structural approach, as credit spread changes can be
easily viewed as an excess return on corporate bonds over Treasury bonds. We try to assess the relative
importance of market and idiosyncratic factors as an explanation of movements in credit spreads. We adopt
a heterogeneous panel with a multifactor error model and propose a two-step estimation procedure, which
yields consistent estimates of unobserved factors. The analysis is carried out with a panel of monthly
redemption yields on a set of corporate bonds for a time span of 3 years. Our results suggest that the euro
corporate market is driven by observable and unobservable factors. The unobservable factors are identified
through a consistent estimation of individual and common observable effects. The empirical results suggest
that an unobserved common factor has a significant role in explaining the systematic changes in credit
spreads. However, in contrast to evidence regarding US credit spread changes, it cannot be identified as
a market factor