The Financial Premium

Abstract

We show that bonds issued by financial firms have higher spreads than bonds issued by industrial firms with the same rating and maturity, and we call this difference the financial premium. During the period 1987-2020 the premium is on average 43bps in the U.S., higher for lower ratings, higher in financial crises, and is increasing in bond beta.  We derive a model that explains the financial premium: banks hold diversified portfolios of non-financial debt and bank debt therefore reflect more systematic risk than non-financial debt.

Keywords: Credit spreads, risk premia, financial institutions, systematic risk, bond beta

JEL Classification: C23, G12