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The pricing of risk in European credit and corporate bond markets

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Author Info
Antje Berndt () (Tepper School of Business, GSIA Room 317A, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213, USA.)
Iulian Obreja () (Tepper School of Business, GSIA Room 317A, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213, USA.)
Abstract

This paper investigates the determinants of the default risk premia embedded in the European credit default swap spreads. Using a modified version of the intertemporal capital asset pricing model, we show that default risk premia represent compensation for bearing exposure to systematic risk and to a new common factor capturing the proneness of the asset returns to extreme events. This new factor arises naturally because the returns on defaultable securities are more likely to have fat tails. The pricing implications of this new factor are not limited to credit markets only. We find that this common factor is priced consistently across a broad spectrum of corporate bond portfolios. In addition, our asset pricing tests also document patterns that are consistent with the so called "flight to quality" effect. JEL Classification: G12, G13, G15.

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Paper provided by European Central Bank in its series Working Paper Series with number 805.

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Length: 53 pages
Date of creation: Aug 2007
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Handle: RePEc:ecb:ecbwps:20070805

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Keywords: Credit default swap default risk premium European credit market European corporate bond markets risk factors.

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  11. Matthieu Darracq Pariès & Stéphane Adjemian & Stéphane Moyen, 2007. "Optimal monetary policy in an estimated DSGE for the euro area," Working Paper Series 803, European Central Bank. [Downloadable!]
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  14. Jukka Jalava & Ilja Kristian Kavonius, 2007. "Durable goods and their effect on household saving rations in the euro area," Working Paper Series 755, European Central Bank. [Downloadable!]
  15. Philipp Engler & Michael Fidora & Christian Thimann, 2007. "External imbalances and the US current account - how supply-side changes affect an exchange rate adjustment," Working Paper Series 761, European Central Bank. [Downloadable!]
  16. Henrique S. Basso & Oscar Calvo-Gonzalez & Marius Jurgilas, 2007. "Financial dollarization - the role of banks and interest rates," Working Paper Series 748, European Central Bank. [Downloadable!]
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