The National (of course, American) Bureau of Economic Research recently published a paper titled “Corporate Bond Default Risk: A 150-Year Perspective,” which CBS MoneyWatch summarized in an article. I could not access the paper free of charge because I could not fit in any category, but I believe the summary by CBS is worth noting. So here it goes: my summary of the CBS summary, plus some thoughts of mine for those numbers.
The long-run average default risk, for the period of 1866-2008 is 1.5% - a rather high number if you ask me. They are not just listed companies - but they are powerful enough to issue bonds. During the Great Depression, the default rate was well over 10%, but this is nothing compared to the whopping 36% default during the railroad crisis of 1873-1875. Without these outliers, the average will be smaller.
Default events had weak correlation (about .26) with business downturns. Recession indicators have little predictive ability with regard to corporate defaults. Defaults showed their own patterns over time, and had a cycle of about 3.2 years, which is longer than the business cycle.
The credit spread was only 1.53%. I think this is already quite small, but the realized premium for the spread was only .8%. Realized premium was quite low compared to the yield the bonds had when purchased. This is natural, because the yield is there to compensate for all kinds of risks - default, illiquidity, risks from embedded options if any, etc. Yield never equals expected return, but investors confuse them and keep chasing after high-yield bonds.
This, coupled with the 2012 investment outlook from Canadian Business (dated Jan 23, 2012), perhaps we should go with equities, and entrench ourselves in the long-term perspective, and behave like an institutional investor. Most of the companies listed in NYSE today, I believe, will still be there after 20 years.
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