On bounding credit-event risk premia

Jennie Bai, Pierre Collin-Dufresne, Robert S. Goldstein, Jean Helwege

Research output: Contribution to journalReview articlepeer-review

5 Scopus citations

Abstract

Reduced-form models of default that attribute a large fraction of credit spreads to compensation for credit-event risk typically preclude the most plausible economic justification for such risk to be priced, namely, a contemporaneous drop in the market portfolio. When this "contagion" channel is introduced within a general equilibrium framework for an economy comprising a large number of firms, credit-event risk premia have an upper bound of a few basis points, and are dwarfed by the contagion premium. We provide empirical evidence that indicates credit-event risk premia are less than 1 bp, but contagion risk premia are significant.

Original languageEnglish (US)
Pages (from-to)2608-2642
Number of pages35
JournalReview of Financial Studies
Volume28
Issue number9
DOIs
StatePublished - Jan 1 2015

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