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RFS Advance Access published online on November 3, 2004
Review of Financial Studies, doi:10.1093/rfs/hhi009
Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved
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Original Articles

Is Default Event Risk Priced in Corporate Bonds?

Joost Driessen 1*
1 Finance Group, Faculty of Economics and Econometrics, University of Amsterdam, Roetersstraat 11, 1018 WB, Amsterdam, The Netherlands

* To whom correspondence should be addressed.
Joost Driessen, E-mail: j.j.a.g.driessen{at}uva.nl


  Abstract

We provide an empirical decomposition of the default, liquidity, and tax factors that determine expected corporate bond returns. In particular, we estimate the risk premium associated with a default event. The intensity-based model is estimated using bond price data for 104 US firms and historical default rates. We find significant risk premia on common intensity factors and important tax and liquidity effects. These components go a long way towards explaining the level of expected corporate bond returns. Adding a positive default event risk premium helps to explain the remaining error, although this premium cannot be estimated with high statistical precision.


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