Gestion du risque de crédit

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The Journal of Financial Research • Vol. XXIX, No. 3 • Pages 421–439 • Fall 2006

CREDIT SPREADS AND THE ZERO-COUPON TREASURY SPOT CURVE

Nicolas Papageorgiou
HEC Montreal

Frank S. Skinner
University of Surrey

Abstract
We examine the relation between credit spreads on industrial bonds and the underlying Treasury term structure. We use zero-coupon spot rates to eliminate the couponbias and to allow for a consistent study both within and across the different credit ratings. Our results indicate that the level and slope of the Treasury term structure are negatively correlated with changes in the credit spread on investment-grade corporate bonds. We also find that the relation between credit spreads and the Treasury term structure is relatively stable through time. This is goodnews for value-at-risk calculations, as this suggests that the correlations among assets of different credit classes are stable; therefore use of historic correlations to model spread relations can be valid. JEL Classification: G21, G24

I. Introduction In January 1996, the Basle committee on Banking Supervision adopted new capital requirements to cover the market risk exposure resulting fromthe daily trading activities of banks. The most important implication of these new capital requirements was that banks could now employ internal risk measurement models to calculate their minimum regulatory capital requirements. In contrast to market risk, models for other types of risk exposures were considerably less advanced and capital requirements for these risks remained subject to theexisting regulatory framework instituted by the 1988 Basel Accord. Over the last few years, however, financial institutions have made large strides in developing statistical models to measure these other sources of risk, most notably credit risk. The Banking Committee is revising
We would like to thank Chris Brooks, Apostolos Katsaris, and Arthur Warga for valuable comments, as well as participants ofthe International Credit Risk conference in Montreal and Financial Management Association Europe conference in Copenhagen. Nicolas Papageorgiou would also like to thank the Research Office at HEC Montreal for financial support. Any errors are our own.

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the regulatory capital standards and has recently proposed a system that permits somesophisticated banks to use internal credit risk models to calculate certain credit risk parameters. Nonetheless, there are still several issues, specifically pertaining to model estimation and validation, that need to be addressed before internal credit risk models can take their place next to their market risk counterparts. The main empirical problem is that, unlike market risk where daily liquid priceobservations allow a direct calculation of value at risk (VaR), credit risk is more complicated to quantify. Apart from the obvious lack of market data, the most significant difference pertains to the horizon for which we are calculating VaR. For market risk, we usually consider a one-day horizon, and the portfolio of securities is marked-to-market on a daily basis. Credit VaR calculations considera longer time horizon (usually one year), rendering them more difficult to estimate and backtest the VaR model. As a result, these credit risk models generally use a combination of historical data and simulation techniques to estimate the required parameters needed for the VaR calculations. One of the key empirical considerations of these credit risk models is how to parameterize the relationbetween Treasury and corporate interest rates. Changes in the shape of the underlying Treasury term structure affect not only the price of corporate securities but also the market’s perception of default risk. It is therefore essential to have a clear understanding of this relation to properly estimate credit VaR. We attempt to shed light on the relation between the credit spreads on fixed-income...
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