Re-Examining the Credit Premium

Abstract

Using the Ibbotson/Sinquefield data documenting the returns of long-term government and corporate bonds, Asvanunt and Richardson [2017] find a sizable investment-grade credit premium that is also statistically significant after accounting for exposure to equity, size, value and momentum factors. In this piece, I focus on the Ibbotson/Sinquefield data starting in 1969 when the series began directly referencing the Salomon Brothers High-Grade Long-Term Corporate Bond Index spliced with Bloomberg/Barclay’s data starting in August 1988 and separately the Bloomberg/Barclay’s data going back to 1973. For both series, I find a weaker credit premium that is not statistically significant after adjusting for equity market factors.

The differences in findings appear to be driven by the abnormally high investment-grade credit (IGC) premium associated with the early history of the Ibbotson/Sinquefield data. An examination of that early history calls into question whether the data is truly representative of investment-grade corporate bond returns net of defaults and downgrades. The primary results questioning the early period data are 1) a significantly higher Sharpe Ratio for the IGC premium compared to either equities or interest rate risk during a period encompassing the Great Depression 2) anomalously high returns during the 30s, which was a period of significant credit stress 3) an IGC premium in excess of 2.5 percent per year in this early period for an index focused on Aa and Aaa corporate bonds and 4) most significantly, an IGC premium embedded in the Ibbotson/Sinquefield data that seems completely disconnected from the frequency of corporate bond defaults reported by Moody’s during common periods of time. Consequently, I argue that the two samples I focus on are likely more representative of the true returns associated with the IGC premium while still retaining the advantages of a longer-term sample, which motivated the work by Asvanunt and Richardson.

Keywords: Corporate Bonds, Credit Risk, Credit Risk Premium

JEL Classification: G11, G12