The Term Structure of Risk Premia: Evidence from CDS Spreads

Abstract

This study estimates the term structure of risk premia before and during the 2007/2008 financial crisis using a new approach based on credit default swaps. Credit markets offer the unique possibility to estimate risk premia for distinct maturities, which considerably facilitates the estimation of the term structure of risk premia. Wefind that the risk premium term structure was fllat before the crisis and downward sloping during the crisis. We provide several robustness tests to show that our results are not driven by counterparty risk, a biased measurement of the real-world default probability, or liquidity.

Keywords: time-varying risk premia, return predictability, credit risk, equity premium, structural models of default

JEL Classification: G12, G13