Corporate Credit Risk Premia

Abstract

for research assistance, and to Linda Bethel and Sandra Berg for technical assistance. This paper is a comprehensive revision of our previous work, entitled "Measuring Default Risk Premia from Default Swap Rates and EDFs." The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. At least one co-author has disclosed a financial relationship of potential relevance for this research. Further information is available online at http://www.nber.org/papers/w24213.ack NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

Credit Risk and the Transmission of Interest Rate Shocks

“…Similarly, Hilscher and Wilson (2017) suggest that CDS contain additional information on top of credit ratings. Berndt, Douglas, Duffie, and Ferguson (2018), a related paper, discusses time series and cross sectional patterns in CDS. Among many other things, the authors show that a large portion of CDS spread movements is determined by factors outside of physical default probabilities.…”

Government Guarantees and the Valuation of American Banks

“…3 The quantitative value of government guarantees depends critically on the risk neutral probability of a crisis state. In section 4, we use data on the realized returns on broad portfolios of corporate bonds from Asvanunt and Richardson (2016), as well as estimates of the credit risk premium from Berndt, Douglas, Duffie, and Ferguson (2017), to measure exposure to aggregate credit risk and to calibrate the risk neutral probability of a crisis. Based on these data, we calibrate the risk neutral probability of the crisis state to 5% on an annual basis.…”

“…We also use information from recent studies of the expected credit risk premium on investment grade corporate bonds relative to similar duration Treasury bonds by Asvanunt and Richardson (2016) and Berndt, Douglas, Duffie, and Ferguson (2017). The expected risk premium on any asset relative to another asset is the expected value of the excess return under the physical probabilities p(s).…”

“…Next, consider the evidence on the expected credit risk premium, which, through equation ( 21), puts a lower bound on the realized excess returns on corporate bonds in normal times. In Table 1, we present the expected credit risk premia estimated by Asvanunt and Richardson (2016) over the 1988-2014 time period and by Berndt, Douglas, Duffie, and Ferguson (2017) over the 2002-2015 time period. 22 To map these data to our model to calibrate the risk-neutral probability q(n), we use the realized excess returns on these various portfolios as a measure of the realized excess return on a portfolio of assets with the credit risk in corporate bonds in the crisis state c, which we denote by R(c) − i.…”

“…See Table3ofBerndt, Douglas, Duffie, and Ferguson (2017) for the median credit risk premia by credit rating.23 In our model, we abstract from interest rate risk. Clearly, the BAML portfolio of AAA bonds is not completely riskless because it is subject to interest rate risk, so its return does not correspond to the riskless rate i.…”