Estimating Bond Yields from Credit Ratings and Comparable Spreads

Summary

The document asks how to quantify the relationship between bond yields and credit ratings when observations are unevenly distributed across rating categories, especially in lower-rated areas. The response suggests consulting high-yield bond indices with rating-based sub-indices as potential reference data. It cautions that there is no universal mapping between rating and yield because market conditions affect the relationship.

For estimating a prospective issuer’s bond yield, the response outlines a comparable-bond approach: use similar bonds’ spread-to-worst figures to estimate a credit spread, add that spread to the yield to maturity of a government benchmark with a matching maturity, and include an allowance for new-issue pricing. The answer offers a practical pricing heuristic rather than a statistical model for interpolation or dependence estimation. It gives no validation, calibration details, or guidance for sparse data, so the proposed inputs and premium need market-specific judgment.

Key ideas

• Rating-based sub-indices from high-yield bond benchmarks can provide reference yield data.
• The relationship between ratings and yields varies with market conditions.
• Comparable bonds’ spread-to-worst figures can inform an issuer’s estimated credit spread.
• A benchmark government yield of matching maturity can be combined with the estimated spread and a new-issue allowance.

Tags

# Credit Rating vs Bond Yield


# Credit Rating vs Bond Yield












I am looking for some references on quantifying the dependence between credit rating and bond yield. I have some data (found some Bloomberg indices which give average yield based on credit rating), but it is dense in some regions and sparse or non-existent in others.

I would like to model this somehow, especially in low-B rating area... Could you please recommend me some references and/or some ideas?

Thank you very much.

UPDATE Related Question on interpolating probabilities of default

## Answer by user68318 (score 1, accepted)

https://quant.stackexchange.com/a/76235

One potential solution would be to look at a high yield bond index, as suggested by the OP. Both J.P. Morgan and BofA publish sub-indexes based on issuer rating, for instance (think Barclay's might too). In general, though, there is no hard-and-fast rule, as it's really market-condition dependent.

When pricing a bond, one good way is to look at some comps, use their spread-to-worst data to figure out a reasonable credit spread for a potential issuer, add the spread to the YTM for the corresponding benchmark government-bond maturity, and then add 25-50 basis points as a new-issue premium for good measure.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.