Abstract

http://ssrn.com/abstract=687473
 
 

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On the Relation between the Credit Spread Puzzle and the Equity Premium Puzzle


Long Chen


Cheung Kong Graduate School of Business

Pierre Collin-Dufresne


Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute; National Bureau of Economic Research (NBER)

Robert S. Goldstein


University of Minnesota - Twin Cities - Carlson School of Management; National Bureau of Economic Research (NBER)

January 2008

AFA 2006 Boston Meetings Paper

Abstract:     
Structural models of default calibrated to historical default rates, recovery rates, and Sharpe ratios typically generate Baa-Aaa credit spreads that are significantly below historical values. However, this credit spread puzzle can be resolved if one accounts for the fact that default rates and Sharpe ratios strongly covary; both are high during recessions and low during booms. As a specific example, we investigate credit spread implications of the Campbell and Cochrane (1999) pricing kernel calibrated to equity returns and aggregate consumption data. Identifying the historical surplus consumption ratio from aggregate consumption data, we find that the implied level and time-variation of spreads match historical levels well.

Number of Pages in PDF File: 59

Keywords: Equity premium, credit spread, habit formation model

JEL Classification: G11, G12

working papers series


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Date posted: March 16, 2005 ; Last revised: July 1, 2011

Suggested Citation

Chen, Long and Collin-Dufresne, Pierre and Goldstein, Robert S., On the Relation between the Credit Spread Puzzle and the Equity Premium Puzzle (January 2008). AFA 2006 Boston Meetings Paper. Available at SSRN: http://ssrn.com/abstract=687473 or http://dx.doi.org/10.2139/ssrn.687473

Contact Information

Long Chen
Cheung Kong Graduate School of Business ( email )
Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China
Pierre Collin-Dufresne
Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute ( email )
Quartier UNIL-Dorigny, Bâtiment Extranef, # 211
CH-1015 Lausanne
Switzerland
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Robert S. Goldstein (Contact Author)
University of Minnesota - Twin Cities - Carlson School of Management ( email )
19th Avenue South
Minneapolis, MN 55455
United States
612-624-8581 (Phone)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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