Time Varying Default Risk Premia in Corporate Bond Markets
McGill University; Swedish Institute for Financial Research (SIFR)
McGill University - Desautels Faculty of Management
June 22, 2007
Paris December 2007 Finance International Meeting AFFI-EUROFIDAI Paper
We develop a methodology to study the linkages between equity and corporate bond risk premia and apply it to a large panel of corporate bond transaction data. We and that a significant part of the time variation in bond default risk premia can be explained by equity implied bond risk premium estimates. We compute these estimates using a recent structural credit risk model. In addition, we show by means of linear regressions that augmenting the set of variables predicted by typical structural models with equity-implied bond default risk premia significantly increases explanatory power. This in turn suggests that time varying risk premia are a desirable feature for future structural models.
Keywords: corporate bonds, credit risk, structural model, volatility, default risk premia, idiosyncratic risk
JEL Classification: G12, G13working papers series
Date posted: March 20, 2007 ; Last revised: May 13, 2009
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