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.
Jumbo CDs are considered a "volatile" liability because relatively large uninsured balances and short maturities force issuing banks to match yields (risk-free rates plus
default premiums) available in the money market or lose the funding.
Fama, 1986, "Term Premiums and
Default Premiums in Money Markets", Journal of Financial Economics, 17:175-196
Then the current value of a loan will equal its face value plus the present value of expected
default premiums minus the present value of the expected losses.
With the above reasoning in mind, our null hypothesis in testing for
default premiums in bid-ask spreads for yen-dollar currency swaps is that par bond yields exceed swap rates.
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].(2) Thus, DCDTB is considered an adequate indicator of changes in the perception of the risk of the banking industry beyond the economy-wide default risk captured by DPREM.
If we allowed the government to break its contractual promises without having to pay compensation, such a policy would come at a high cost in terms of increased
default premiums in future government contracts and increased disenchantment with the government generally.(61) As with incentive subsidies, whether those costs would outweigh the benefits from the additional flexibility that is gained by permitting the government to disregard its contractual obligations is an empirical question that I do not pretend to answer with any certainty.
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.
Ng, 1991, "
Default Premiums in Commodity-Markets--Theory and Evidence", Journal of Finance, 46:1071-1093
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.
