November 22, 1999


Enclosed is the latest issue of the New York Fed’s Current Issues in Economics and Finance, Credit Risk in Japan’s Corporate Bond Market.

Yield spreads in Japan’s corporate bond market increased sharply in the last few years, suggesting that concerns with credit risk, historically a minor factor in the pricing of corporate bonds, are causing a major change in the structure of the market.

Senior economist Frank Packer examines pricing patterns in the Japanese corporate bond market from the fall of 1997 to the spring of 1999, a period when the spreads between yields on corporate and Japanese government bonds began a steep increase and eventually doubled. According to Packer, weak macroeconomic conditions during the period can explain some—but not all—of the rise in yield spreads. Two pieces of evidence suggest that structural changes in the Japanese bond market are also responsible.

First, yield spreads have become increasingly correlated with credit ratings, a key measure of creditworthiness, over the past few years. According to Packer, this change suggests that the pricing of corporate bond issues is now much more closely tied to credit risk than in the past.

Second, yield spreads have increased the most among firms that belong to a keiretsu—an informal network of large firms that maintain close business, managerial, and financial ties. Historically, membership in a keiretsu was thought to provide companies at risk of defaulting on their bonds with a financial safety net. The disproportionately large increase in spreads among keiretsu firms, however, indicates that membership in a keiretsu may be considered less of a safeguard than in the past.

Both of these findings provide evidence that a "credit culture" is taking root in Japan, Packer says. As the traditional assumptions about protections against default disappear, the market valuation of bond issues is increasingly based on the credit risk of individual issuers, according to Packer.

Contact: Douglas Tillett

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