Abstract
Using implied-CDS risk premium measures, we find that these variables have higher explanatory power for cross-sectional bond returns than the traditional default spread and ratings. The positive effect of the credit risk premium (CRP) factor on expected returns is pervasive, stronger for lower-rated bonds and robust to controlling for conventional risk factors and bond characteristics. Besides the systematic CRP factor, idiosyncratic credit risk is also priced. The results show that the CRP beta effect in the cross-section of bond returns is largely a pure bond effect, which is not driven by the underlying structural model relationship between debt and equity.
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