ABSTRACT
The addition of a yield spread (or credit spread) over the equivalent near-maturity, risk-free benchmark, such as the on-the-run U.S. Treasury bond, or note, for U.S. dollar issues, is the industry approach to reflect the issuer’s credit worthiness and the associated default and liquidity risks pertinent to the risky instrument being priced (De Almeida, Duarte, and Fernandes 1998). Structural models of default, such as the model proposed by Longstaff and Schwartz (1995), provide a simple and intuitive framework to capture the factors that drive yield spreads. Empirical evidence from the mature markets of the United States and Japan among others (Collin-Dufresne, Goldstein, and Martin 2001) points to two main factors-the asset factor and the interest rate factor-as the key drivers of changes in credit spreads. However, the generality of the developed market evidence to emerging markets and the understanding of the factors that drive these credit spreads, which are structurally and otherwise different from those in mature markets, is limited.
