The Pricing of Interest Rate and Credit Risks in Equity Returns : An Empirical Cross-Country Comparison

In this study, we examine whether changes in the investment opportunityset stemming from interest rate and credit risks are priced in the US, theUK and the Swiss equity premia by estimating both two-factor and three-factor versions of Merton’s ICAPM. The systematic pricing of credit riskis confirmed for all three markets and for alternative specifications of theinterest rate variables. The credit risk premium represents between 20 and30% of the total equity premium in each country and is thus an importantdecision variable for portfolio management purposes. Finally, we find thatmarket and credit risks are jointly positively and significantly priced in theUS and Swiss equity risk premia.