The market price of credit risk and economic states

This paper proposes a market-wide credit risk factor for the US stock market and investigates its properties that are dependent on economic conditions. The market price of credit risk is found to be statistically significantly negative, supporting earlier studies. However, a sample-split analysis reveals that this negative payoff is nonexistent in a later subsample, indicating that the credit risk puzzle is based on temporary mispricing related to the earlier subsample. Further investigation shows that mispricing in the earlier period was mainly driven by positive payoffs of low credit risk firms, while high credit risk firms did not generate significant returns in any of the sub-periods.