Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market





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    • Longstaff is with the Anderson School at UCLA and the National Bureau of Economic Research. Mithal is with Archeus Capital Management LLC. Neis is a Ph.D. student at the Anderson School at UCLA. We are grateful for valuable comments and assistance from Dennis Adler, Warren Bailey, Jacob Boudoukh, Sanjiv Das, Darrell Duffie, John Hull, Joseph Langsam, Jun Liu, Jun Pan, Matt Richardson, Eduardo Schwartz, Jure Skarabot, Soetojo Tanudjaja, Alan White, and Ryoichi Yamabe, and from seminar participants at the University of California at Riverside, Kyoto University, the London School of Business, New York University, Nomura Securities, the University of Southern California, and the University of Texas at Austin. We are particularly grateful for the comments of the editor Robert Stambaugh and an anonymous referee. All errors are our responsibility.


We use the information in credit default swaps to obtain direct measures of the size of the default and nondefault components in corporate spreads. We find that the majority of the corporate spread is due to default risk. This result holds for all rating categories and is robust to the definition of the riskless curve. We also find that the nondefault component is time varying and strongly related to measures of bond-specific illiquidity as well as to macroeconomic measures of bond market liquidity.