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Default Risk, Default Risk Premiums, and Corporate Yield Spreads

39 Pages Posted: 1 Mar 2006  

Georges Dionne

HEC Montreal - Department of Finance

Geneviève Gauthier

HEC Montreal - Department of Decision Sciences; HEC Montreal - Department of Management Sciences

Khemais Hammami

HEC Montreal - Department of Finance

Mathieu Maurice

HEC Montréal

Jean-Guy Simonato

HEC Montréal

Date Written: June 1, 2006

Abstract

An important research area of the corporate yield spread literature seeks to measure the proportion of the spread explained by various factors such as the possibility of default, liquidity or tax differentials. We contribute to this literature by assessing the ability of observed macroeconomic factors and the possibility of changes in regimes to explain the default risk proportion in yield spreads. For this purpose, we extend the Markov Switching risk-free term structure model of Bansal and Zhou (2002) to the corporate bond setting and develop recursive formulas for default probabilities, risk-free and risky zero-coupon bond prices. The model is calibrated with consumption, inflation, risk-free yield and default data over the 1987-1996 period. Preliminary results show that up to 64% of the ten years corporate yield spread for industrial Baa is explained by the possibility of default.

Keywords: Corporate yield spread, default risk, default risk premium, credit spread level puzzle, macroeconomic risk premium

JEL Classification: G11, G12, G13, G21, G23

Suggested Citation

Dionne, Georges and Gauthier, Geneviève and Hammami, Khemais and Maurice, Mathieu and Simonato, Jean-Guy, Default Risk, Default Risk Premiums, and Corporate Yield Spreads (June 1, 2006). EFA 2006 Zurich Meetings. Available at SSRN: https://ssrn.com/abstract=887380 or http://dx.doi.org/10.2139/ssrn.887380

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Genevieve Gauthier

HEC Montreal - Department of Decision Sciences ( email )

3000 Côte-Sainte-Catherine Road
Montreal, QC H2S1L4
Canada

HEC Montreal - Department of Management Sciences ( email )

Montreal, Quebec H3T 2A7
Canada

Khemais Hammami

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Mathieu Maurice

HEC Montréal ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Jean-Guy Simonato

HEC Montréal ( email )

3000, chemin de la Cote-Sainte-Catherine
Service de l'enseignement de la finance
Montreal, Quebec H3T 2A7
Canada
514-340-6807 (Phone)
514-340-5632 (Fax)

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