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| Premia for Correlated Default Risk by Shahriar Azizpour of Stanford University, and November 30, 2008 Abstract: Credit investors are exposed to the correlated movements in issuers' conditional default rates due to changes in common risk factors, and the jumps of default rates caused by the contagious impact of a default event on the other rms. This article measures the risk premia investors require for bearing that exposure during April 2004--October 2007. We develop and estimate from an extensive data set of corporate defaults and market rates of CDX High Yield and Investment Grade index and tranche swaps a reduced-form model of correlated firm default under actual and risk-neutral probabilities. Our likelihood estimators indicate that CDX investors require substantial premia for the diffusive mark-to-market risk that is caused by firms' common factor exposure, and the jump-to-default risk in swap values that comes from the impact of a default on the portfolio constituents. Risk premia vary dramatically across time, portfolio composition, and holding period. Keywords: Correlated default, feedback, intensity, risk premia, measure change, pricing kernel. Books Referenced in this Paper: (what is this?)
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