Explaining the Rate Spread on Corporate Bonds
by Edwin J. Elton of New York University,
Abstract: The purpose of this article is to explain the spread between rates on corporate and government bonds. We show that expected default accounts for a surprisingly small fraction of the premium in corporate rates over treasuries. While state taxes explain a substantial portion of the difference, the remaining portion of the spread is closely related to the factors that we commonly accepted as explaining risk premiums for common stocks. Both our time series and cross-sectional tests support the existence of a risk premium on corporate bonds.
Published in: Journal of Finance, Vol. 56, No. 1, (February 2001), pp. 247-277.