Review of Financial Studies Vol. 28 No. 9 2015
On Bounding Credit-Event Risk Premia
Abstract
Reduced-form models of default that attribute a large fraction of credit spreads to compensation for credit-event risk typically preclude the most plausible economic justification for such risk to be priced, namely, a contemporaneous drop in the market portfolio. When this "contagion" channel is introduced within a general equilibrium framework for an economy comprising a large number of firms, credit-event risk premia have an upper bound of a few basis points, and are dwarfed by the contagion premium. We provide empirical evidence that indicates credit-event risk premia are less than 1 bp, but contagion risk premia are significant.
- Volume
- 28
- Issue
- 9
- Pages
- 2608-2642
- Sources
- bibtex:phds-export.bib