Commonality in Credit Spread Changes: Dealer Inventory and Intermediary Distress
Zhiguo He, Fuji Bank and Heller Professor of Finance
Two intermediary-based factors – a broad distress measure and a corporate bond inventory measure – explain 50% of the puzzling common variation of credit spread changes beyond canonical structural factors. A simple margin-based model accounts for this co-movement and delivers further implications with empirical support. First, whereas bond sorts on margin-related variables produce monotonic loading patterns on intermediary factors, non-margin-related sorts produce no pattern. Second, dealer inventory co-moves with corporate-credit assets only, whereas intermediary distress co- oves even with non-corporate-credit assets. Third, dealers’ inventory responds to (instrumented) bond sales by institutional investors. Fourth, bond-factor sensitivities flip signs during regulatory tightening.