Junk bond spreads and credit
default premiums are at their lowest levels since before the Lehman Brothers collapse; but they are still well above the levels seen before the financial system began to come apart in 2007.
Specifically, we generate risk rankings using jumbo CD
default premiums and quarter-over-quarter withdrawals for banks with satisfactory supervisory ratings.
Fama, 1986, "Term Premiums and
Default Premiums in Money Markets", Journal of Financial Economics, 17:175-196
Swap rates are compared to yields on equal maturity bonds to measure
default premiums.
The spread changes significantly in response to changes in the business cycle, the general level of interest rates, problems in the banking industry, and monetary policy and institutional changes and there is evidence of the existence of significant
default premiums in CD rates [Baer and Brewer, 1986; Fama, 1986; Hannan and Hanweck, 1988; Ellis and Flannery, 1992].
Whether such a policy would be efficient, again, depends upon the tradeoff between the benefits of reduced
default premiums and costs of reduced government flexibility.
Their results further show that such fluctuations may depend, to a large extent, on whether the observed
default premiums on such instruments fully reflect the premiums demanded by investors.
We show later in this paper that the conventional contingent claims model due to Merton |18~ is unable to generate
default premiums in excess of 120 basis points, even when excessive debt ratios and volatility parameters are used in the numerical simulation.
Default premiums and yields on risky assets is still significantly inflated from last year's lows despite government guarantees and liquidity.
The VIX and DailyFX Volatility indexes have both maintained their decline,
default premiums are still in a long-term bear trend (though they recently jumped) and the yield advantage on relatively risky assets has lessened with growing interest.
The VIX is just off its nine-month lows, the Bloomberg-derived Junk bond spread has extended its steady depreciation to October lows and credit
default premiums are near their lowest levels in nearly a year.
In contrast, junk bond spreads and credit
default premiums are climbing.
