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We analyze risk premia in credit and equity markets by exploring the joint cross-section of credit default swaps (CDS) and stocks for US firms from 2001 to 2010. Structural models imply that (risk-adjusted) excess returns in both markets are driven by the relation between a firm's risk-neutral and real-world default probability. We extract information about this relation from credit markets by estimating risk premia embedded in the term structure of CDS spreads using a single-factor model in the spirit of Cochrane and Piazzesi (2005). Consistent with predictions from structural models, we find a strong positive relation between CDS-implied risk premia and equity risk premia: firms' equity excess returns increase with CDS-implied risk premia. CDS spreads contain equity-relevant information beyond size and book-to-market but excess returns are highest for small firms and value stocks. Our results are robust across pre-crisis and crisis subsamples, return weighting schemes, and CDS data sources.JEL classification: G12, G13

We derive a formula for the expected return on a stock in terms of the risk-neutral variance of the market and the stock's excess risk-neutral variance relative to that of the average stock. These quantities can be computed from index and stock option prices; the formula has no free parameters. The theory performs well empirically both in and out of sample. Our results suggest that there is considerably more variation in expected returns, over time and across stocks, than has previously been acknowledged.

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This is the unspecified version of the paper.This version of the publication may differ from the final published version. Permanent AbstractWe study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating affine (multi-currency) term structure models reveals a noticeable tradeoff between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global affine model generate unbiased predictions for currency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals.JEL classification: F31; E43; G10.