RISK-AVERSION AND THE YIELD OF CORPORATE-DEBT

This paper develops a model to estimate the implied default probabilit y of corporate bonds. The model explicitly considers the risk averse b ehavior of investors to provide a more precise framework for estimatin g the implied default probability. A Kalman filter method is used to e stimate time-varying risk premium associated with the investor's risk aversion. The results of nonlinear regressions indicate that previous risk-neutrality models consistently overestimate the implied default r ates of corporate bonds. The results also suggest that investors may h ave been adequately compensated for investment in risky bonds.