EFFECT OF DEFAULTS AND CREDIT DETERIORATION ON YIELDS OF CORPORATE BONDS

THE AUTHORS WERE faced with the problem of estimating the size of reserve which would have been necessary for absorbing losses on mediumand high-grade corporate bonds during the first half of this century. Upon searching the literature to see what help could be gained from past authorities, we found that there is a gap between the doctrines by theorists as to the kind of experience expectable and the best published statistics of realized yields and loss rates.' We are passing along the results of a small effort to plug this gap in the hope that it will help others who are similarly faced with the necessity of using the record of the past performance of corporate bonds in connection with problems of evaluation of probable future performance. Theorists in the field of investments seem generally to offer support for the idea that some reserve is desirable. This is found in such doctrines that, in contrast with common stocks, where either gain or loss may be expected, the nature of the contract in unconvertible corporate bonds severely limits the possibilities of gain but leaves quite open the possibilities of loss up to 100 per cent. Again, there is the doctrine that bond investment is a "negative art," requiring principally the gauging of the chances for loss and the estimating of what premium in yield is appropriate for acceptance of those chances. Many writers have regarded the difference between the prospective yield from market price on a bond and the yield prevailing at the same time on riskless securities of similar term as consisting mainly