The purpose of this article is to explain the spread between rates on corporate and government bonds. We show that expected default accounts for a surprisingly small fraction of the premium in corporate rates over treasuries. While state taxes ex- plain a substantial portion of the difference, the remaining portion of the spread is closely related tot he factors that we commonly accept as explaining risk premiums for common stocks. Both our time series and cross-sectional tests support the ex- istence of a risk premium on corporate bonds.
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