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A Note on Sector, Rating, and Maturity Effects on Risk Premia

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  • Konstantinos Drakos

    (Department of Economics, University of Patras, Greece)

Abstract

Focusing on a set of investment grade corporate yields covering four industries, three maturities, and four ratings, principal components analysis is employed in order to estimate the number of common factors that account for their sample covariance structure. The empirical findings suggest that a two-factor representation is statistically acceptable, a finding consistent with previous research as well as with existing theoretical models. Furthermore, we explore the role of rating, maturity, and sector in explaining cross-sectional differences across investment grade yields¡¦ risk premia. We conclude that these factors account for a large and significant part of the observed variation. Additionally, we are able to estimate the quantitative effect of these factors on the risk premium embodied in credit spreads.

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Bibliographic Info

Article provided by College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan in its journal International Journal of Business and Economics.

Volume (Year): 3 (2004)
Issue (Month): 3 (December)
Pages: 201-216

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Handle: RePEc:ijb:journl:v:3:y:2004:i:3:p:201-216

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Related research

Keywords: corporate yields; maturity; principal components; rating; sector;

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References

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  1. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  2. Cooper, Ian A & Mello, Antonio S, 1991. " The Default Risk of Swaps," Journal of Finance, American Finance Association, vol. 46(2), pages 597-620, June.
  3. Drakos, Konstantinos, 2002. "Common Factors in Eurocurrency Rates: A Dynamic Analysis," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 17, pages 164-184.
  4. Fase, M M G, 1976. "The Interdependence of Short-Term Interest Rates in the Major Financial Centres of the World: Some Evidence for 1961-1972," Kyklos, Wiley Blackwell, vol. 29(1), pages 63-96.
  5. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
  6. Trzcinka, Charles A, 1986. " On the Number of Factors in the Arbitrage Pricing Model," Journal of Finance, American Finance Association, vol. 41(2), pages 347-68, June.
  7. Gregory R. Duffee, 1998. "The Relation Between Treasury Yields and Corporate Bond Yield Spreads," Journal of Finance, American Finance Association, vol. 53(6), pages 2225-2241, December.
  8. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December.
  9. Connor, Gregory & Korajczyk, Robert A, 1993. " A Test for the Number of Factors in an Approximate Factor Model," Journal of Finance, American Finance Association, vol. 48(4), pages 1263-91, September.
  10. Kuo, Weiyu & E. Satchell, Stephen, 2001. "Global equity styles and industry effects: the pre-eminence of value relative to size," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 11(1), pages 1-28, March.
  11. Fase, M. M. G., 1973. "A principal components analysis of market interest rates in The Netherlands, 1962-1970," European Economic Review, Elsevier, vol. 4(2), pages 107-134, June.
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