DP8714 Scattered Trust - Did the 2007-08 financial crisis change risk perceptions?

Author(s): Roland Füss, Thomas Gehrig, Philipp B Rindler
Publication Date: December 2011
Keyword(s): ambiguity aversion, counterfactual analysis, credit spreads, quantile regression, structural models
JEL(s): C21, G12
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8714

The paper investigates whether the financial crisis did affect risk perceptions, and, hence, change structural parameters. By decomposing credit spreads of US corporate bonds into the contributions by credit, equity, and liquidity risk factors as well as structural change, the relative contribution of the change in risk perceptions can be measured. We show that this increase is mostly due to aversion to default risk for high-yield bonds. For low-yield bonds, the increase is mostly due to liquidity related factors. By means of counterfactual analysis we find that the financial crisis shifted the distribution of bond spreads almost uniformly. This evidence is consistent with changing risk perceptions as predicted by theories of ambiguity aversion or social learning in the case of rare events.