Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - What drives corporate default risk premia?
T2 - evidence from the CDS market
AU - Diaz, Antonio
AU - Groba, Jonatan
AU - Serrano, Pedro
PY - 2013/10
Y1 - 2013/10
N2 - This article studies the economic factors behind corporate default risk premia in Europe during the period 2006-2010. We employ information embedded in Credit Default Swap (CDS) contracts to quantify expected excess returns from the underlying bonds in market-wide default circumstances. We disentangle the compensation to investors for unexpected changes in the creditworthiness of the bond issuer from their remuneration for the risk that the bond’s price will drop in the event of default. Our results show that the risk premia associated with systematic factors influencing default arrivals represent approximately 40% of total CDS spread (on median). These premia also exhibit a strong source of commonality; a single principal component explains approximately 88% of their joint variability. This factor significantly covaries with aggregate illiquidity and sovereign risk variables. Empirical evidence suggests a public-to-private risk transfer between sovereign credit spread and corporate risk premia. Finally, the compensation in the event of default is approximately 14 basis points of the total CDS spread, and a significant amount of jump-at-default risk may not be diversifiable.
AB - This article studies the economic factors behind corporate default risk premia in Europe during the period 2006-2010. We employ information embedded in Credit Default Swap (CDS) contracts to quantify expected excess returns from the underlying bonds in market-wide default circumstances. We disentangle the compensation to investors for unexpected changes in the creditworthiness of the bond issuer from their remuneration for the risk that the bond’s price will drop in the event of default. Our results show that the risk premia associated with systematic factors influencing default arrivals represent approximately 40% of total CDS spread (on median). These premia also exhibit a strong source of commonality; a single principal component explains approximately 88% of their joint variability. This factor significantly covaries with aggregate illiquidity and sovereign risk variables. Empirical evidence suggests a public-to-private risk transfer between sovereign credit spread and corporate risk premia. Finally, the compensation in the event of default is approximately 14 basis points of the total CDS spread, and a significant amount of jump-at-default risk may not be diversifiable.
KW - Credit default swap
KW - Distress risk premium
KW - Expected default frequency
KW - Jump-at-default risk premium
U2 - 10.1016/j.jimonfin.2013.07.003
DO - 10.1016/j.jimonfin.2013.07.003
M3 - Journal article
VL - 37
SP - 529
EP - 563
JO - Journal of International Money and Finance
JF - Journal of International Money and Finance
SN - 0261-5606
ER -