50 Pages Posted: 14 Feb 2015 Last revised: 5 Aug 2016
Date Written: June 21, 2016
Despite theoretical and intuitive reasons for a credit risk premium, past research has found little supporting empirical evidence. This is primarily due to biases in computing credit excess returns which improperly account for term risk. Using data spanning 80 years in the U.S., and nearly 20 years in Europe, we find strong evidence of credit risk premium after correctly adjusting for term risk. The credit risk premium is not spanned by other known risk premia and exhibits time variation related to economic growth and aggregate default rates. These results have important implications for asset pricing and investment decisions.
Keywords: risk premium, credit risk, asset allocation
JEL Classification: G11, G12
Suggested Citation: Suggested Citation