Following the reduced-form models of corporate bond pricing, specifically Duffee (1999) and Jarrow, Lando and Yu (2003), this study investigates corporate bond credit spreads by distinguishing the idiosyncratic component from the systematic component of credit risk. Starting from a framework of affine model, we find that the idiosyncratic credit spreads do not respond empirically to Treasury yields, unlike what is suggested in the structural model of Longstaff and Schwartz (1995) and literatures that follow. Systematic credit spreads are however positively related to Treasury yields in the long-run, but negatively so in the short run, suggesting the validity of both the tax and the option hypotheses. A long-run and optimal decomposition scheme yields an idiosyncratic credit spread measure at a median of 60 b.p. for the Baa index and is specifically compatible with Duffee's model. It is insensitive to interest rate in the short-run, but would rise slightly with a positive shock in the long run at a one to a hundred rate. The idiosyncratic credit spreads provide significant inferences about the observed conditional corporate bond default rate while the full credit spread does not.
