Abstract
In this paper, we document and rationalize the premium paid by bond issuers in the corporate bond markets. Changes in the bond market over the past thirty years have shifted the new issue pricing risk from investors to banks and back to investors, with large institutional investors acting as a de facto adjunct underwriting group, and this process has required both capital commitment as well as a commitment to taking on unsystematic risk for which investors require compensation. In this paper, we use the superior data prevalent in trades under the TRACE system to compute the New-Issue Premium (NIP) as well as relating the magnitude of that premium to predetermined economic variables: The level of the corporate-bond spread; the future volatility of swap spreads; the prevailing value of unsystematic risk in the bond markets; the spread of the issuer to Treasury market at time of issuance; and the tenor of the new bond issue. We then present a model for the required NIP based on compensation for information uncertainty and the bearing of unsystematic risk. In so doing, we also address the issues of oligopolistic pricing and wealth transfer that occur at time of issuance.
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