Mind The Gap: Decomposing the Credit Spread Puzzle : An empirical analysis of credit risk pricing in the Norwegian Corporate Bond Market in the period 2014-2023

Abstract

This thesis presents a comprehensive analysis of the credit spread puzzle in the Norwegian corporate bond market, a topic that has been largely unexplored since 2015. Focusing on the period from 2014 to 2023, we aim to quantify the extent of the puzzle, identify additional risk premiums demanded by investors, and explore the factors driving these premiums. Our analysis of 30,647 transactions reveals that the median proportion of actual credit spreads explained by default models is 28 percent. We observe sector-specific variations, with industrial, oil, and shipping sectors showing significant mispricing. Our findings indicate that Norwegian investors seek additional compensation for sector-specific risks, particularly in the volatile industrial, oil, and shipping sectors, and for bonds from smaller issuers. A notable size premium is evident, especially in sectors susceptible to economic downturns. The study also suggests a substantial liquidity premium, challenging to quantify due to the market’s illiquid nature. The research contributes to understanding the Norwegian corporate bond market’s complexities, highlighting the nuanced nature of bond pricing beyond what standard models can explain.