NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Christopher L. Culp

Johns Hopkins Institute
for Applied Economics
Global Health and Study
of Business Enterprise
3400 North Charles St.
Baltimore, MD 21218

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NBER Working Papers and Publications

December 2014Option-Based Credit Spreads
with Yoshio Nozawa, Pietro Veronesi: w20776
We present a novel empirical benchmark for analyzing credit risk using “pseudo firms” that purchase traded assets financed with equity and zero-coupon bonds. By no-arbitrage, pseudo bonds are equivalent to Treasuries minus put options on pseudo-firm assets. Empirically, like corporate spreads, pseudo-bond spreads are large, countercyclical, and predict lower economic growth. Using this framework, we find that bond market illiquidity, investors’ over-estimation of default risks, and corporate frictions do not seem to explain excessive observed credit spreads, but, instead, a risk premium for tail and idiosyncratic asset risks is the primary determinant of corporate spreads.
 
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