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Category: Bonds & Fixed Income * The Credit Spread Puzzle
VisitThe credit spread puzzle Popular Last Update: Nov/13/2007 14:29
Jeffery D. Amato and Eli M. Remolona, "The Credit Spread Puzzle," BIS Quarterly Review, December 2003, p 51-63 < >

Introduction: "Spreads on corporate bonds tend to be many times wider than what would be implied by expected default losses alone. These spreads are the difference between yields on corporate debt subject to default risk and government bonds free of such risk. While credit spreads are often generally understood as the compensation for credit risk, it has been difficult to explain the precise relationship between spreads and such risk. In 19972003, for example, the average spread on BBB-rated corporate bonds with three to five years to maturity was about 170 basis points at annual rates. Yet, during the same period, the average yearly loss from default amounted to only 20 basis points. In this case, the spread was more than eight times the expected loss from default. The wide gap between spreads and expected default losses is what we call the credit spread puzzle."

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