Predicting Credit Spread Dynamics in the Norwegian Corporate Bond Market : An empirical analysis of High Yield and Investment Grade bonds in the Period 2014-2022

This thesis examines the credit spread dynamics between High Yield (HY) and Investment Grade (IG) bonds in the Norwegian corporate bond market. The sample consists of monthly pricing data for 37 distinct bonds spanning from 2014 to 2022. We apply the extended Merton model (Eom et al., 2004) to calculate model credit spreads further used in the analysis. The first part of the analysis is a regression analysis comparing the mispricing between HY and IG bonds. Applying several non-defaultrelated variables, we explore the differences in mispricing, both in terms of explanatory power and their relative magnitude. The second part of the analysis is a regression analysis aiming to predict credit spread differences between HY and IG. We find that the model underpredicts credit spreads for HY but overpredicts credit spreads for IG. Furthermore, modelled credit spreads explain 3.1% of the variance in observed credit spreads for HY bonds and 1.9% for IG bonds. We identify that both risk grades are broadly affected by the same variables but with different magnitudes. HY appears to be more sensitive to industry dynamics and market risk compared to IG. Lastly, leverage plays a pivotal role in explaining variance in credit spread differences, having an explanatory power of 83.6%.