Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2008/9: Credit Spreads and Incomplete Information

Snorre Lindset (), Arne-Christian Lund () and Svein-Arne Persson ()
Additional contact information
Snorre Lindset: Trondheim Business School, Postal: HiST, TØH, Jonsvannsveien 82, 7004 TRONDHEIM, Norway
Arne-Christian Lund: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
Svein-Arne Persson: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: A new model is presented which produces credit spreads that do not converge to zero for short maturities. Our set-up includes incomplete, i.e., delayed and asymmetric information. When the financial market observes the company's earnings with a delay, the effect on both default policy and credit spreads is negligible, compared to the Leland (1994) model. When information is asymmetrically distributed between the management of the company and the financial market, short credit spreads do not converge to zero. This is result is similar to the Duffie and Lando (2001) model, although our simpler model improves some limitations in their set-up. Short interest rates from our model are used to illustrate effects similar to the dry-up in the interbank market experienced after the summer of 2007.

Keywords: Credit risk; credit spreads; delayed information; asymmetric information

JEL-codes: G12; G33

39 pages, March 12, 2008

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