Default Risk Premium and Asset Prices
44 Pages Posted: 30 May 2015 Last revised: 3 Apr 2020
Date Written: March 31, 2020
This paper quantifies the premium demanded by the investors for bearing the corporate default risk. We propose a novel approach that exploits the information in both credit default swap (CDS) spreads and stock prices, using the pricing restrictions provided by a structural model of credit risk. By pinning down the daily dynamics of the market value of debt, we deliver daily estimates of the full term structure of the default risk premium for worldwide non-financial firms. We show that the premium declines with the time horizon, with the lower premia paid at the longer debt maturity. Moreover, we show that the dynamics of the default risk premium may predict opposite dynamics of equity and CDS prices across firms.
Keywords: Structural Estimation, Kalman Filter, Default Risk, Distress Puzzle
JEL Classification: C4, G12, G32, G33
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