Market conditions, default riskand credit spreads

This is study empirically examine the impact of market conditions on credit spreads asmotivated by recently developed structural credit risk models. Using credit default swap(CDS) spreads, we find that, in the time series, average credit spreads are decreasing inGDP growth rate, but increasing in GDP growth volatility. We document that creditspreads are lower when investor sentiment is high and when the systematic jump riskis low. In the cross section, we confirm that firm-level cash flow volatility raises creditspreads. More importantly, we demonstrate that the impact of market conditions oncredit spreads is substantially affected by firm heterogeneity. During economic expansions,ceteris paribus, firms with high cash flow betas have lower credit spreads thanthose with low cash flow betas. This relation disappears during economic recessions,consistent with theoretical predictions....