TY - JOUR T1 - Dynamics of Credit Spreads JF - The Journal of Fixed Income SP - 28 LP - 35 DO - 10.3905/jfi.2001.319295 VL - 11 IS - 2 AU - Karan Bhanot Y1 - 2001/09/30 UR - https://pm-research.com/content/11/2/28.abstract N2 - 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. ER -