Bond premium in Turkey - Inflation risk or default risk?

Başçı E., Ekinci M.

EMERGING MARKETS FINANCE AND TRADE, vol.41, no.2, pp.25-40, 2005 (SSCI) identifier identifier

  • Publication Type: Article / Article
  • Volume: 41 Issue: 2
  • Publication Date: 2005
  • Doi Number: 10.1080/1540496x.2005.11052602
  • Journal Name: EMERGING MARKETS FINANCE AND TRADE
  • Journal Indexes: Social Sciences Citation Index (SSCI), Scopus
  • Page Numbers: pp.25-40
  • Keywords: asset pricing, bond premium, default risk, equity-premium puzzle, inflation risk, EQUITY PREMIUM, DEBT, BRAZIL
  • TED University Affiliated: No

Abstract

In this paper we examine the difference between T-bill returns and common stock returns in Turkey. We observe that there is a bond premium in Turkey unlike the equity premia in developed countries. As an attempt to explain this surprising observation, we incorporate inflation risk and default risk to the Mehra and Presscott (1985) dynamic asset-pricing model. Calibration with reasonable parameter values indicates that the inflation risk alone is not sufficient to explain the observed bond premium. However, by allowing for the presence of a perceived default probability, we can explain the observed bond premium on Turkish T-bills over Turkish common stocks.