Abstract: This paper investigates the source for common variation in the portion of re-turns observed in U.S. credit markets that is not related to changes in risk free-rates or expected default losses. We extract a latent common component from firm specific changes in default risk premia that is orthogonal to known systematic risk factors during our sample period from 2001 to 2004. Asset pricing tests using returns on Bloomberg-NASD corporate bond indices suggest that our discovered latent changes in default risk premia (DRP) factor is priced in the corporate bond market. A cross-sectional analysis of Merrill Lynch corporate bond portfolios sorted on either industry, maturity or rating supports these findings. In our tests we control for firm characteristics and find that the common variation in changes in default risk premia is not likely to be due to these. Using portfolios of put options written on the S&P 500 index and sorted on moneyness and maturity, we find that, for far-out-of-the-money options, both average returns and the beta estimate for our DRP factor increase with increasing time to maturity. The same holds true for out-of-the-money and at-the-money index put options. There is little to no evidence, however, of the DRP factor being priced in the equity markets. We develop a theoretical framework that, while the DRP factor is part of the pricing kernel, supports our empirical findings. It shows that the DRP factor captures the jump-to-default risk associated with market-wide credit events.