NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Yoshio Nozawa

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NBER Working Papers and Publications

December 2014Option-Based Credit Spreads
with Christopher L. Culp, 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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