On Bounding Credit-Event Risk Premia

AFA

48 Pages Posted: 13 Nov 2012 Last revised: 23 Jul 2018

See all articles by Jennie Bai

Jennie Bai

Georgetown University - Department of Finance; National Bureau of Economic Research (NBER)

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)

Jean Helwege

UC Riverside

Date Written: February 28, 2015

Abstract

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 contemporaneous drop in the market portfolio. When this "contagion" channel is introduced within a general equilibrium framework for an economy comprising a large number of firms, credit-event risk premia have an upper bound of a few basis points, and are dwarfed by the contagion premium. We provide empirical evidence that indicates credit-event risk premia are less than 1 bp but contagion risk premia are significant.

Keywords: credit risk model, contagion

JEL Classification: G12, G13

Suggested Citation

Bai, Jennie and Collin-Dufresne, Pierre and Goldstein, Robert S. and Helwege, Jean, On Bounding Credit-Event Risk Premia (February 28, 2015). AFA, Available at SSRN: https://ssrn.com/abstract=2175108 or http://dx.doi.org/10.2139/ssrn.2175108

Jennie Bai (Contact Author)

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States

HOME PAGE: http://www.jenniebai.com

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny, Bâtiment Extranef, # 211
40, Bd du Pont-d'Arve
CH-1015 Lausanne, CH-6900
Switzerland

Swiss Finance Institute

c/o University of Geneva
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CH-1211 Geneva 4
Switzerland

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Robert S. Goldstein

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

Jean Helwege

UC Riverside ( email )

900 University Ave.
Anderson Hall
Riverside, CA 92521
United States
9518274284 (Phone)

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