The Pricing of Interest Rate and Credit Risks in Equity Returns: An Empirical Cross-Country Comparison

In this study, we examine whether changes in the investment opportunity set stemming from interest rate and credit risks are priced in the US, the UK and the Swiss equity premia by estimating both two-factor and three-factor versions of Merton's ICAPM. We also study the degree of dependence and causality between the domestic credit risk premia in order to assess the potential benefits of international diversification. We find only weak evidence of systematic interest rate risk pricing, while we observe that market and credit risks are both positively and significantly priced. Finally, we fail to observe strong relationships between the credit risk premia estimated on the three stock markets.