Risk Aversion and the Yield of Corporate Debt

• Main Authors: WU, Chunchi, Yu, C.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 1996
• Subjects: Business
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/801
• Institution: Singapore Management University

This paper develops a model to estimate the implied default probability of corporate bonds. The model explicitly considers the risk averse behavior of investors to provide a more precise framework for estimating the implied default probability. A Kalman filter method is used to estimate time-varying risk premium associated with the investor's risk aversion. The results of nonlinear regressions indicate that previous risk-neutrality models consistently overestimate the implied default rates of corporate bonds. The results also suggest that investors may have been adequately compensated for investment in risky bonds.