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On bounding credit event risk premia

  • Jennie Bai
  • Pierre Collin-Dufresne
  • Robert S. Goldstein
  • Jean Helwege
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    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 “contagious” response of the market portfolio during the credit event. When this channel is introduced within a general equilibrium framework for an economy comprised of a large number of firms, credit event risk premia have an upper bound of just a few basis points and are dwarfed by the contagion premium. We provide empirical evidence supporting the view that credit event risk premia are minuscule.

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    Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 577.

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    Date of creation: 2012
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    Handle: RePEc:fip:fednsr:577
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