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How Much of Corporate-Treasury Yield Spread is Due to Credit Risk?Jing-Zhi HuangPennsylvania State University - University Park - Department of Finance Ming HuangCornell University - Samuel Curtis Johnson Graduate School of Management September 12, 2012 Forthcoming in the Review of Asset Pricing Studies 14th Annual Conference on Financial Economics and Accounting (FEA); Texas Finance Festival; 2003 Western Finance Association Meetings Abstract: We show that credit risk accounts for only a small fraction of yield spreads for investment-grade bonds of all maturities, with the fraction lower for bonds of shorter maturities, and that it accounts for a much higher fraction of yield spreads for high yield bonds. This conclusion is shown to be robust across a wide class of structural models. We obtain such results by calibrating each of the models to be consistent with data on the historical default loss experience and equity risk premia, and demonstrating that different models predict similar credit risk premia under empirically reasonable parameter choices.
Number of Pages in PDF File: 57 Keywords: Credit risk, credit spread puzzle, time varying risk premia, jumps and stochastic asset volatility JEL Classification: G0, C0 Accepted Paper SeriesDate posted: January 15, 2004 ; Last revised: October 5, 2012Suggested CitationContact Information
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