Finance Faculty Publications and Presentations

Document Type

Article

Publication Date

Fall 2017

Abstract

Extracting information from daily CDS spreads, we propose a measure of correlated default risk, which we show is a meaningful predictor of bankruptcy clusters. Focusing on U.S. corporate bonds, we also find that our measure of correlated default risk is more pronounced and commands a higher premium during periods of financial distress and for speculative issues. For instance, we find that after controlling for other known determinants of bond pricing, a 0.5 increase in aggregate correlated default risk is associated with a 13-bps increase in credit spreads, and elevates to a 22-bps premium for speculative issues and to a 17-bps premium during periods of financial distress. Overall, our paper provides compelling evidence as to the efficacy of our measure in capturing correlations in the likelihood of default over time, and has important implications for future work in asset allocation and fixed-income pricing.

Comments

Original published version available at doi.org/10.3905/jfi.2017.27.2.006

First Page

6

Last Page

29

Publication Title

The Journal of Fixed Income

DOI

10.3905/jfi.2017.27.2.006

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