Sample Description

As shown in Table 3.2, the median firm has 6 issues observed at various times over a period of 6.22 years, with an average time step between trading days of 0.0262 years, or approximately 10 calendar days. For the median firm, the term structure spans from a minimum remaining term to maturity of 1.12 years to a maximum of 19.71 years. Note that because more than one of the issuer’s bonds may trade on the same day, the median firm’s number of trades of 261, exceeds the median firm’s number of trading days of 233.

Table 3.3: This table shows the frequency distribution of credit spread observations within the sample. Industry refers to the industrial sector of the issuing firm, Issuers is the count of issuing firms, and Trades are the counts of bond trades.

Issuers Issues Trades

Industry No. (%) No. (%) No. (%)

Industrial 22 68.8 125 62.5 5,963 66.6

Finance 6 18.8 52 26.0 1,997 22.3

Utility 4 12.5 23 11.5 993 11.1

Totals 32 100.0 200 100.0 8,953 100.0

Duffee (1999, Table 1) applies a similar estimation method on 161 issuers reported in the FID database. He uses month-end quotes and monthly time partitions compared to our use of actual trades with a 10 day average interval between trades. His median firm has 92 month-ends over 7.6 years, which equates to 227 bid quotes compared to our 261 actual trades. Thus, we have slightly more data per issuer, with information on the firm’s default risk observed approximately three times as frequently.

Table 3.3 shows that industrial firms comprise 62.5 percent of our sample by num- ber of issues, followed by finance at 26.0 percent, and utilities at 11.5 percent. EHH exclude financial firms and their sample includes only 5.5 percent in transport and utili- ties. Table 3.4 shows the sample credit spreads by rating and remaining maturity at the time of their trade. As expected the median credit spread is higher for poorer ratings and higher for longer dated maturities. Davydenko & Strebulaev (2004, Table II) report similar results for credit spread levels and sample standard deviations across a larger sample (43,402 trades in total compared to our 8,953) confirming that our sample is rep- resentative of the larger NAIC universe. Our median credit spread is 81 basis points, increasing from 50 basis points for AA trades, 78 basis points for A, 97 basis points for BBB, and up to 157 basis points for BB trades.3 Table 3.4 shows that spreads are on average, monotonic with remaining maturity; spreads for AA and BBB are lower for the medium tenors than the short maturities (4 basis points for AA and 13 for BBB medians) and only one basis point higher for A rated issuers. The expected monotonic increase is present in long maturities where we find all spreads are greater than shorter maturities.

Table 3.5 shows the credit spread descriptive statistics, after controlling for gearing, matching solvency and credit spreads on the date of trade. It is convenient to express sol- vency in a manner that is consistent with structural credit modelling. We therefore use an observable proxy that hereafter is referred to as the observed log-solvency ratio (S), de- fined as the natural log of the inverse of the observed leverage ratio,S=ln((D+E)/D), whereDis the total book value of debt, andE is the market value of equity. Book val-

3_{The comparable median spreads from Davydenko & Strebulaev (2004, Table II) are 51, 71, 103 and}

Table 3.4: This table reports the descriptive statistics of the sample credit spreads by issuer rating and remaining maturity, coincident with the trade date. All credit spreads are reported in basis points.

All AA A BBB BB Panel A: All Mean 102 62 91 115 312 Median 81 50 78 97 157 Std. Dev. 124 36 51 109 486 5% quantile 31 23 34 45 86 95% quantile 201 132 189 218 1,465 n 8,953 1,691 3,704 3,263 295

Panel B: Remaining Maturity≤7 years

Mean 102 61 89 117 378 Median 73 51 70 96 159 Std. Dev. 158 36 58 145 628 5% quantile 28 24 28 39 64 95% quantile 207 132 201 212 1,729 n 4,107 875 1,687 1,409 136

Panel C: Remaining Maturity 7−15 years

Mean 93 60 84 100 270 Median 75 47 71 83 155 Std. Dev. 93 36 45 68 328 5% quantile 32 20 40 48 97 95% quantile 182 129 175 185 1,285 n 3,407 727 1,266 1,276 138

Panel D: Remaining Maturity>15 years

Mean 120 77 108 142 166 Median 109 65 100 121 163 Std. Dev. 57 35 37 72 32 5% quantile 60 44 60 83 122 95% quantile 217 159 181 246 209 n 1,439 89 751 578 21

ues of debt are quarterly values reported by COMPUSTAT (items 45 and 51), and the market value of equity is obtained from CRSP for the day of the trade. Lower values of log-solvency measure greater levels of debt relative to firm value. As expected, Table 3.5 shows that, on average, higher credit spreads are associated with lower levels of solvency as expected. The median spread in the upper quartile of log-solvency is 65 basis points and 99 basis points in the lowest quartile. Also observable is a higher median spread associated with longer remaining maturity for all quartiles of log-solvency except the upper quartile (lowest default risk). In Figure 3.3 the time series of the median monthly sample credit spread and Moody’s generic corporate spread indexes are shown. The me- dian spread has a 90.4 percent correlation with the Moody’s Aaa index levels and 41.4 percent in first differences with the index showing that our sample of firms exhibits simi- lar time series behaviour relative to the wider universe of publicly traded debt. The level of our median credit spreads aligns most closely with the Moody’s Aaa index although our most frequently observed sample corporate rating is single A. This is possibly due to our sample selection method that favors mature listed firms with frequently traded, and therefore, relatively more liquid bonds.

Across our sample and the Moody’s indexes, there is a general upward shift in credit spreads during the sample period. Most noticeable is the sharp increase in credit spreads in August 1998 when the Russian default and LTCM bail-out triggered a rise in sec- ondary market yields (hereafter we refer collectively as the LTCM crises). The effect of the LTCM crises on market-wide bond credit spreads is shown in Table 3.6. Before 1 August 1998, the sample average credit spread is 70 basis points. After 1 August 1998, the average increases to 159 basis points. Controlling for rating, the rise in spreads post the LTCM crises is just over double the pre-crises values for ratings AA, A, and BBB. The increase, is however much larger for the highest default grade BB, being an increase of around six and a half times.