PT - JOURNAL ARTICLE AU - Karan Bhanot TI - Dynamics of Credit Spreads AID - 10.3905/jfi.2001.319295 DP - 2001 Sep 30 TA - The Journal of Fixed Income PG - 28--35 VI - 11 IP - 2 4099 - https://pm-research.com/content/11/2/28.short 4100 - https://pm-research.com/content/11/2/28.full AB - This article uses a particular non-parametric approach to examine the conditional drift and variance of credit spreads. The data include Moody's Aaa and Bbb seasoned bond index yields for the period February 1977 through May 2001. The results show that the drift function is linear and mean-reverting for Aaa index spreads, but Bbb spreads show a strong non-linearity in the drift function. Around its mean, the drift of Bbb spreads is essentially zero, behaving like a random walk, but it mean-reverts strongly when far away from the mean. For pricing and hedging applications, the affine class of parametric diffusion specifications is therefore likely to work well for Aaa spreads, while a non-linear specification is preferable for Bbb spreads.