The Financial Premium
45 Pages Posted: 27 Dec 2022
Date Written: December 23, 2022
We show that bonds issued by financial firms have higher spreads than bonds issued by industrial firms with the same rating and we denote this difference the financial premium. During the period 1987-2020 the premium was on average 43bps in the U.S. corresponding to a 31% higher spread and the premium is higher for lower ratings and in financial crises. Furthermore, the premium relates to measures of systemic risk and predicts economic activity. We derive a model that explains the empirical results: banks hold a diversified portfolio of corporate bonds (loans) and bank bonds therefore reflect more systematic risk than the individual corporate bonds.
Keywords: Credit Spreads, Risk Premia, Financial institutions, Systemic risk
JEL Classification: C23; G12
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