Defaults and Credit Spreads

Sort of a relationship

Continuing with default rates from yesterday, let’s add credit spreads to the chart:

This is one of those relationships that is sort of there and sort of not.

Defaults are weird and, ultimately, binary. They either happen or they don’t. Spreads live on a spectrum, so we can’t expect a perfectly smooth match with default behavior.

Following the Great Depression, there was a long period of credit rationing. Then, things got looser starting in the 80s. One might say the 80s onward is more normal and that is the time period we should look at.

But even from then on the relationship isn’t perfect. It’s close enough though that we could feel comfortable using spreads as an indicator for defaults, especially since spread data is so much more frequently available.

In the end, I would take both metrics and add them to my toolkit. I don’t mind having a bunch to look at, if you haven’t picked up on that already : )