Bridge over ocean
1 May 2011 Financial Analysts Journal Volume 67, Issue 3

Capturing Credit Spread Premium

  1. Kwok-Yuen Ng
  2. Bruce D. Phelps, CFA

Despite high spread volatility, investment-grade credit portfolios have generated an average annual spread premium (returns net of U.S. Treasury returns and defaults) of 48 bps over the past 20 years. The authors show that relaxing a common portfolio constraint that requires selling downgraded bonds would have allowed investors to capture an average annual spread premium of 86 bps, with similar risk. Thus, adopting a downgrade-tolerant credit benchmark could generate a higher credit spread premium.

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