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Why a Corporate Bond Can Have a Negative Z-Spread

Article Quant Q&A · Author: Alessandro Campagna
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Summary

The note explains that a small negative Z-spread can occur for an investment-grade corporate bond. In the example, the observed spread is measured against LIBOR, which may sit above Treasury yields because it includes some bank credit risk. A highly rated corporate bond can therefore yield less than the LIBOR reference curve without the quoted spread necessarily indicating a calculation error.

It also points to bond features such as collateral that may make the issue more valuable, while a basic Z-spread calculation discounts promised cash flows assuming no default. The measure does not itself incorporate default probability or loss given default. The explanation is brief and does not assess the specific bond, verify its market data or curve conventions, or determine whether the reported spread reflects an instrument feature or a calculation issue.

Key ideas

  • A small negative Z-spread can be plausible for an investment-grade corporate bond.
  • A Z-spread depends on its reference curve, and LIBOR may exceed Treasury yields.
  • Collateral or other bond features can affect value without being captured in a basic Z-spread calculation.
  • The described Z-spread treatment does not incorporate default probability or loss given default.

Tags

Fixed incomeDerivatives pricingRisk management
Full text
# Is it possible to have negative Z-spread for a corporate bond?


# Is it possible to have negative Z-spread for a corporate bond?












I have a 2 year maturity AA rated US corporate bonds, and I found that it has negative Z-spread, -0.00053. Does it make sense or it's wrong?

## Answer by Dimitri Vulis (score 0, accepted)

https://quant.stackexchange.com/a/71217

Yes, it's possible for an IG bond to be trading at a small negative Z-spread.

Z-spread is a spread to LIBOR. LIBOR is above treasury because it includes a tiny bit of "common banks" credit risk.

It's also possible that your bond has some features, such as collateral, that make the bond more valuable, but that the Z-spread calculation doen't take into account. Z-spread just looks at the cash flows if the bond does not default, not at probability of default and loss given default.

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.