Corporate bonds are defaultable and thus trade at higher yields than default-free government bonds. However, it has been difficult to reconcile this observed difference in yields (the credit spread) with the historically observed default losses of corporate bonds, especially for investment-grade firms (Elton et al. (2001)).

In particular, Huang and Huang (2003, henceforth HH) analyze a wide range of structural firm value models that build on the seminal contingent-claims analysis of Merton (1974). HH show that these models typically explain only 20% to 30% of observed credit spreads for these firms. In response to this credit spread ‘puzzle’ (Amato and Remolona (2003)), a number of authors have recently incorporated jump risk premia into the analysis. As discussed below, the existing evidence on the relevance of jump risk premia is inconclusive.