Estimating Credit Risk Premia
This paper investigates the nature of the credit risk premium adjustments in the Jarrow-Lando-Turnbull model of credit risk spreads. The adjustments relate the equivalent martingale measures to the empirical measures of unconditional transition probabilities. The author provides a modified version of the risk adjustment that allows a linear partition of the credit spread into an unconditional default component, a recovery component, and the risk premium adjustment. The risk adjustments are related to conditional default risk, illiquidity risk, and other factors not related to recovery effects. The log-transform of these risk adjustments can be specified as linear regressions on a set of macroeconomic variables. Some new insights are gained pertaining to these conditional risks such as a typical upward sloping term structure and sensitivity to short-term treasury rates and increasing forward rates. The conditional risks appear to be insensitive to market returns.
Finance and Financial Management | Portfolio and Security Analysis
Financial Management Association Conference 2005
Lim, Kian Guan.
Estimating Credit Risk Premia. (2005). Financial Management Association Conference 2005. Research Collection Lee Kong Chian School Of Business.
Available at: http://ink.library.smu.edu.sg/lkcsb_research/2785