Credit Information Ambiguity Premia

Abstract

This paper proposes credit information ambiguity (CIA) as a pricing factor. We recursively estimate CIA as the statistical proximity of predicted firm survival probabilities of major credit rating agencies, using credit ratings and historical default rates. The CIA factor positively and significantly explains expected bond returns, predicting around 15% of bond return premia. A multi-factor model capturing the cross-section of CIA, credit rating, and downside risk consistently prices average corporate bond returns. The results remain robust to alternate specifications and multiple hypothesis testing. CIA also predicts CDS spreads and stock returns. A model using uncertainty aversion justifies the results.

Keywords: Credit Information Ambiguity, Bond Uncertainty Premia, Return Predictability

JEL Classification: G12, G14, G24