A Pure Test for the Elasticity of Yield Spreads

where ∆S is the monthly change in the absolute yield spreads, ∆Y_T-bill is the monthly change
in the yield on a three-month Government of Canada treasury bill, and ∆Slope is the monthly
change in the spread between the constant maturity long-term Government of Canada yield
and the three-month treasury bill yield.

Collin-Dufresne et al.’s (2001) findings indicate that monthly changes in firm-
specific attributes are not the driving force in credit-spread changes. Thus we also run the
following regression for each index:

∆S = β0 + β1∆YLT + β2 (∆YLT) ² + β3∆Slope + β4I + ε,            (4)

where ∆YLT is the monthly change in the constant maturity long-term Government of Canada
yield and the remaining variables are as defined above.

Following Fridson, Garman and Wu’s (1997) prediction, we estimate the following
regression for each index:

∆S=β0+β1∆π+β2∆YLT,R +ε                                        (5)

where ∆S is the monthly change in the yield spread, ∆YLT,R is the monthly change in the real
yield on the constant maturity long-term Government of Canada index, ∆π is the monthly
change in the consumer-price index (CPI) that proxies the inflation rate.

5. Empirical Results

The results from applying the three regression models introduced in the first section,
namely the Longstaff and Schwartz (1995) two-factor model, Duffee’s (1998) term-structure
model and Collin-Dufresne et al.’s (2001) comprehensive model are now reported.

5.1 Longstaff and Schwartz’s (1995) two-factor model.

In Table 2, we report the OLS estimates for the Longstaff and Schwartz (1995) regression
models. They use both absolute and relative spreads in their analysis.¹⁰ Panel A of Table 2
outlines the estimates for our entire sample, covering the 08:1976-07:2001 25-year period.
Corporate bonds carrying a standard call provision dominate the data during this sample

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