Abstract

This paper provides new evidence on the empirical success of structural models in explaining corporate credit risk changes. A parsimonious set of common factors and firm-level fundamentals, inspired by structural models, explains more than 54 % (67%) of the variation in credit spread changes for medium (low) grade bonds. No dominant latent factor is present in the unexplained variation. While our set of variables has lower explanatory power among high-grade bonds, it does capture most of the systematic variation of credit-spread changes in that category as well. It also subsumes the explanatory power of the Fama and French (1993) factors among all grade classes. This paper assesses the success of structural models in empirical studies of changes in corporate credit spreads. Our focus is set on the change in the credit spread, not its level. 1 The difference in studying credit spreads vs. changes in credit spreads is equiv-alent to the difference in studying equity prices vs. equity expected returns. Indeed, there is a one-to-one correspondence between the spread level and the bond price, while

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