Why would modeling credit risk using bond spreads/prices overstate the credit risk exposure?
Credit risk is simply the risk that a borrower will not meet its obligations. However, bond spreads and prices are comprised of more factors than simply credit risk. Part of the spread is the Risk Free Rate, which is the return expected/demanded by the market to overcome inflation factors and still provide a gain. Other intrinsic rate determinants include credit ratings, market fluctuations, and a constantly changing demand curve for financial instruments (i.e. Choice between equities and debt by individual/portfolio investors). As you can expect, all of these factors can affect bond prices and spreads without any change occurring in the credit risk of the underlying instrument. I hope this helps. Good luck!
