EQUITY VOLATILITY COMPONENTS AND CORPORATE CREDIT SPREADS

Abstract

This paper decomposes equity volatility into the systematic and idiosyncraticcomponents and examines how they affect corporate credit spreads. Therelationship between equity volatility and credit spreads is positive only for firmswith low credit quality. For high credit quality firms, the effect is negative,suggesting that an increase in equity volatility is associated with a narrowerrather than wider credit spread. The positive leg of the relationship is primarilydriven by idiosyncratic volatility, while a decrease in credit spreads of high-qualityfirms is associated with an increase in systematic volatility. The results are robustto controlling for firm size and bond characteristics.