Economic links and credit spreads

Counterparty risk is an important determinant of corporate credit spreads. However, there are only a few techniques available to isolate it from other factors. In this paper we describe a model of financial networks that is suitable for the construction of proxies for counterparty risk. Using data on North American supplier-customer network of public companies, we find that, for each supplier, counterparties' leverage and option implied volatilities are significant determinants of corporate credit spreads in the period after the 2008-2009 U.S. recession. Our findings are robust after controlling for several idiosyncratic, industry, and market factors.