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A. Berndt, A. A. Lookman, and I. Obreja: Default Risk Premia and Asset Returns

March 19, 2006

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.

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