An analysis of all defaults (including distressed exchange offers) on straight debt over the 1977–88 period indicates that annual default loss rates averaged 1.63, with a principal loss of 42.7 per cent. Deleting distressed exchange offers from the default-loss calculation results in a drop in average default rates and only a slight increase in principal loss, suggesting that distressed exchange offers are nearly as harmful to investors as outright defaults. The pattern of defaults over the years, however, indicates that defaults motivated by strategic, rather than financial, considerations are much less harmful to investors than financial insolvency.

The defaults, while concentrated in cyclical industry sectors, occurred across the board. Diversification by industry alone is thus insufficient protection against default. Nor is a strategy of investing only in investment-grade debt any guarantee against default: 42 per cent of the par value of all defaulted debt (and 32 per cent of bond issues) was originally rated investment grade.

Have the premiums on high-yield debt—i.e., the spread over comparable risk-free rates—compensated investors for their risk? In fact, the evidence indicates that investors were overcompensated during the 1977–88 period. Furthermore, the pattern of cumulative excess returns over the four-year period surrounding the default date indicates that investors uncover the signs of financial distress long before a default announcement. The return pattern also suggests a potentially profitable trading strategy: Invest in bankrupt securities at approximately the fifth month after default and sell during the 10th month.