This study includes a total of $26.42 billion of the speculative-grade bonds that defaulted over the 13-year period of 1982 through 1994.
Altman (1989, 1991, 1992) suggests speculative-grade bond risk premiums of 300 to 500 basis points over Treasuries, whereas Hickman (1958) found that, from 1900 to 1943, the annual yield spread between speculative-grade bonds and high-grade bonds was approximately 300 basis points.
Given the results displayed in Tables 3a and 3b, we are 95 percent certain that the true population mean annual loss rate is less than 422 basis points using equal-weights or 626 basis points using market-weights for speculative-grade bonds based on the 13 years covered in this study.
(8.) Market weights are determined by the cumulative par value of all speculative-grade bonds outstanding.
This suggests that speculative-grade bond primary markets efficiently price default risk and that other types of risk are priced as coincident as opposed to orthogonal risks.
Thus, proper consideration of both types of correlation materially affects the size of the confidence interval and may also substantially affect the interpretation of the efficiency of the speculative-grade bond market to accurately price risk.
Much of the market-related systematic risk found in speculative-grade debt is due to markets reacting to changes in the economy in the same manner that the speculative-grade bond market reacts to changes in the economy.
The efficiency and continued viability of speculative-grade bond markets is of considerable importance to future economic growth since 95 percent of all corporations in this country with sales over $35 million do not qualify for investment-grade debt.
The differences between investment-grade and speculative-grade bonds are even more striking when the data are disaggregated by maturity.
The estimated option values for investment-grade bonds average 2.4% of the gross proceeds, compared with 1.46% for the speculative-grade bonds. This difference is driven in large pan by the longer maturities of investment-grade bonds.
Assuming the Kalotay, Williams, and Fabozzi model is accurate, the call dates of the speculative-grade bonds are not sufficiently early to offset the effects of their shorter maturities and higher call prices.