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 o...
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| Format: | text |
| Language: | English |
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Institutional Knowledge at Singapore Management University
2005
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| Online Access: | https://ink.library.smu.edu.sg/lkcsb_research/2785 |
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| Institution: | Singapore Management University |
| Language: | English |
| Summary: | 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. |
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