Credit dislocation

Two bond markets moving in opposite directions

Government yields fall while credit spreads widen, so the bond allocation cannot be treated as one protective block. The hypothetical Treasury sleeve has no spread sensitivity; the corporate sleeve does. Their divergent results follow directly from the exposure mapping, not from an estimated correlation or a simulated flight to safety.

The default corporate sleeve illustrates the competition. Falling yields contribute 2.5 percentage points through duration and 0.04375 points through convexity. Spread widening subtracts 10 points, producing a 7.45625% local loss. The rate benefit exists, but it is much smaller than the separate spread effect.

A spread change is not a default rate

A 250 basis point spread widening is an additional 2.5 percentage points of yield compensation, not a 2.5% probability of default. Federal Reserve discussion of the excess bond premium distinguishes expected default losses from other components of corporate spreads [2]. This engine does not estimate either component separately.

The SEC's corporate-bond bulletin explains default in terms of missed contractual payments and discusses creditor claims [1]. Neither default events nor recoveries are generated here. Spread duration remains fixed, so distressed debt approaching a recovery-value floor may behave very differently from this linear spread approximation.

Keep the spread and rate conventions intact

The same spread shock is applied to all modeled bonds, scaled by each holding's nonnegative spread duration. It does not vary by rating, seniority, sector or maturity. Zero spread duration removes this modeled channel; it does not prove that the instrument is free of every credit-related risk.

Credit shocks may range from minus 300 to plus 1,000 basis points, but acceptance is not evidence of economic plausibility. Convexity adjusts only the government-rate movement. There is no spread convexity, rate-spread interaction or sensitivity update, and a local price loss reaching 100% causes rejection rather than a fabricated recovery value.

Keep a market loss separate from a cash shortfall

The corporate-bond bulletin also identifies liquidity risk [1]. A modeled mark is not an executable bid, and this spread shock includes no explicit bid-ask cost, selling schedule or market-impact calculation. Adding a separate liquidation haircut without defining its purpose could overlap risks already intended within the spread assumption.

Assess financing separately using contractual collateral terms, eligible assets and payment deadlines. A bond can retain a positive modeled ending value while being difficult to sell or pledge in time. Conversely, a mark-to-market loss alone does not determine that a margin call occurs or establish its amount.

Review the wider portfolio without diluting the question

The equity shock is a separate fixed-beta loss, not a stock-price forecast inferred from spreads. EUR and GBP weaken while JPY strengthens in the assumptions, with translation compounded after local performance. Those currency terms have no effect on the all-USD reference holdings and do not model currency hedges.

A targeted challenge changes spread duration or the credit shock while preserving the rate assumption, then records whether the offset still fails. Keep issuer-specific defaults, unsupported instruments and sale constraints visible outside that comparison. The preset has no event chronology or calibrated probability, and its total is not a funding-survival test.

Review checkpoints

• Falling government yields need not offset a larger spread-duration loss.
• Do not convert basis points of spread widening into a default probability.
• Evaluate executable prices, collateral terms and cash deadlines separately from modeled marks.

Source notes

1. SEC Investor.gov: What Are Corporate Bonds?
2. Federal Reserve: Jeremy C. Stein, Incorporating Financial Stability Considerations into a Monetary Policy Framework (2014), discussion of the excess bond premium

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