Is Default Event Risk Priced in Corporate Bonds?

We identify and estimate the sources of risk that cause corporate bonds to earn an excess return over default-free bonds. In particular, we estimate the risk premium associated with a default event. Default is modelled using a jump process with stochastic intensity. For a large set of firms, we model the default intensity of each firm as a function of common and firm-specific factors. In the model, corporate bond excess returns can be due to risk premia on factors driving the intensities and due to a risk premium on the default jump risk. The model is estimated using data on corporate bond prices for 104 US firms and historical default rate data. We find significant risk premia on the factors that drive intensities. However, these risk premia cannot fully explain the size of corporate bond excess returns. Next, we estimate the size of the default jump risk premium, correcting for possible tax and liquidity effects. The estimates show that this event risk premium is a significant and economically important determinant of excess corporate bond returns. JEL Codes: E43; G12; G13.