 Downside risk and the size of credit spreadsGordon Gemmill and Aneel Keswani Journal of Banking & Finance, 2011, vol. 35, issue 8, 2021-2036 Abstract: We investigate why spreads on corporate bonds are so much larger than expected losses from default. Systematic factors make very little contribution to spreads, even if higher moments or downside effects are taken into account. Instead we find that sizes of spreads are strongly related to idiosyncratic-risk factors: not only to idiosyncratic equity volatility, but even more to idiosyncratic bond volatility and idiosyncratic bond value-at-risk. Idiosyncratic bond volatility helps to explain spreads because it reflects not just the distribution of firm value but is also a proxy for liquidity risk. Idiosyncratic bond value-at-risk adds to this by capturing the left-skewness of the firm-value distribution. We confirm our results both for the initial 1997-2004 sample period and also out of sample for 2005-2009, which includes the sub-prime crisis. Overall, credit spreads are large because they incorporate a large risk premium related to investors' fears of extreme losses. Keywords: Bond; Idiosyncratic; risk; Downside; risk; Credit; spread; puzzle; Pricing; kernel; Liquidity; Sub-prime; crisis (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:35:y:2011:i:8:p:2021-2036 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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