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Forecastable default risk premia and innovations

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Abstract

We examine the generating process for default risk premia in short-term and long-term debt sectors of the U.S. economy over the recent period of January 1977 through December 1996. Using weekly aggregates reported by the Federal Reserve, this research finds that all univariate series examined have unit roots which suggests a “long memory” for innovations in the series. Models presented here demonstrate an adjusted R2 of 59 to 97 percent in sample with similar hold-out sample results. Long-term investment grade corporate bonds exhibit substantial feedback such that lagged innovations have predictive power for nearby risk classes. In the money markets, the flow of information is from less risky assets to more risky assets.

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Authors and Affiliations

  1. Department of Economics and Finance, College of Business Administration, The University of Texas at El Paso, 79968-0543, El Paso, TX

    Steve A. Johnson

Authors
  1. Patrick A. Traichal
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  2. Steve A. Johnson
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Correspondence to Steve A. Johnson.

Additional information

Patrick A. Trachial, Technology House Inc.

This manuscript has benefited from the comments of Tom Fullerton, Ned Hill, Judy Maese, Ken Martin, Richard Sprinkle, and Bernell Stone. This manuscript was improved by comments received at the 13th International Symposium on Cash, Treasury, and Working Capital management (1997, Honolulu).

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Traichal, P.A., Johnson, S.A. Forecastable default risk premia and innovations. J Econ Finan 23, 214–225 (1999). https://doi.org/10.1007/BF02757706

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