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The pricing of risk in European credit and corporate bond markets

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  • Berndt, Antje
  • Obreja, Iulian

Abstract

This paper investigates the determinants of the default risk premia embedded in the European credit default swap spreads. Using a modified version of the intertemporal capital asset pricing model, we show that default risk premia represent compensation for bearing exposure to systematic risk and to a new common factor capturing the proneness of the asset returns to extreme events. This new factor arises naturally because the returns on defaultable securities are more likely to have fat tails. The pricing implications of this new factor are not limited to credit markets only. We find that this common factor is priced consistently across a broad spectrum of corporate bond portfolios. In addition, our asset pricing tests also document patterns that are consistent with the so called "flight to quality" effect. JEL Classification: G12, G13, G15

Suggested Citation

  • Berndt, Antje & Obreja, Iulian, 2007. "The pricing of risk in European credit and corporate bond markets," Working Paper Series 805, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2007805
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    References listed on IDEAS

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    Cited by:

    1. Paolo Finaldi Russo & Fabio Parlapiano, 2018. "The Drop in Non-Financial Firms' Cost of Credit: A Cross-Country Analysis," Politica economica, Società editrice il Mulino, issue 1, pages 23-44.
    2. Christian Klein & Christoph Stellner, 2014. "The systematic risk of corporate bonds: default risk, term risk, and index choice," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 28(1), pages 29-61, February.

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    More about this item

    Keywords

    credit default swap; default risk premium; European corporate bond markets; European credit market; risk factors;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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