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Credit Risk Taking by Japanese Investors: Is Skewness Risk Priced in Japanese Corporate Bond Market? *1

July 2004
Shinichi Nishioka *2
Naohiko Baba *3

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  • *1 We benefited greatly from discussions with staff members of the Bank of Japan. We are also grateful to Mr. Yoichi Kita of Nikko Financial Intelligence for providing us with Japanese bond data. Any remaining errors are solely our responsibility. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of Japan.
  • *2 Financial Markets Department: E-mail: shinichi.nishioka@boj.or.jp
  • *3 Financial Markets Department: E-mail: naohiko.baba@boj.or.jp

Abstract

This paper aims to analyze risk premium of corporate bonds considering skewness as an additional risk factor under a portfolio selection framework. With skewness, risk premium can be expressed as a weighted average of beta-risk under the orthodox beta-CAPM and gamma-risk arising from skewness. We call the pricing model with gamma-risk gamma-CAPM. The weight between beta-risk and gamma-risk is determined mainly by the degree of relative risk aversion. Empirical results using Japanese data show that (i) specification tests tend to accept gamma-CAPM, rejecting beta-CAPM, and (ii) the estimated values of the degree of relative risk aversion are significantly positive on the whole, but become negative when BBB-rated corporate bonds are included in the sub-sample estimation, which covers the period after the adoption of the zero interest rate policy by the Bank of Japan. Also, empirical results using U.S. data show that (iii) the estimated values of the degree of relative risk aversion are much higher than the values estimated by Japanese data, and (iv) the average weight of gamma-risk is 10.7 percent in the U.S., compared with 3.2 percent in Japan. This means that gamma-risk is priced in U.S. corporate bonds to a larger degree than in the Japanese corporate bonds. These findings imply that Japanese investors have taken excessive credit risk, particularly in BBB-rated corporate bonds under the low interest rate environment.

Keywords:
Corporate Bond, Portfolio Selection, Skewness, Co-Skewness, beta-CAPM, gamma-CAPM