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Time‐Varying Asset Volatility and the Credit Spread Puzzle
Author(s) -
DU DU,
ELKAMHI REDOUANE,
ERICSSON JAN
Publication year - 2019
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12765
Subject(s) - leverage (statistics) , econometrics , asset (computer security) , volatility (finance) , risk premium , economics , credit risk , extant taxon , capital asset pricing model , financial economics , leverage effect , stochastic volatility , actuarial science , computer science , autoregressive conditional heteroskedasticity , computer security , evolutionary biology , biology , machine learning
Most extant structural credit risk models underestimate credit spreads—a shortcoming known as the credit spread puzzle. We consider a model with priced stochastic asset risk that is able to fit medium‐ to long‐term spreads. The model, augmented by jumps to help explain short‐term spreads, is estimated on firm‐level data and identifies significant asset variance risk premia. An important feature of the model is the significant time variation in risk premia induced by the uncertainty about asset risk. Various extensions are considered, among them optimal leverage and endogenous default.