Measuring Default Risk Premia from Default Swap Rates and EDFs

This paper estimates recent default risk premia for U.S. corporate debt, based on a close relationship between default probabilities, as estimated by Moody's KMV EDFs, and default swap (CDS) market rates. The default-swap data, obtained through CIBC from 22 banks and specialty dealers, allow us to establish a strong link between actual and risk-neutral default probabilities for the 69 firms in the three sectors that we analyze: broadcasting and entertainment, healthcare, and oil and gas. We find dramatic variation over time in risk premia, from peaks in the third quarter of 2002, dropping by roughly 50% to late 2003